How IRS Form 982 Can Aid Credit Unions and their Members with Debt Settlements

By: Nicholas K. Rohner, Esq.

For any credit union seeking to negotiate with one of its members over a lump-sum settlement of the member’s delinquent, unsecured debt,[1] one potential roadblock is IRS Form 1099-C. This form reports the amount of a member’s debt that is forgiven or canceled; and although a member is unlikely to want any such debt to be taxed as income, credit unions are required by law to issue this form. In light of these facts, the issue becomes how to keep members from walking away from a mutually beneficial settlement.

One possible solution is IRS Form 982, which allows a member to exclude the amount canceled from his income up to the extent of his insolvency at the time the debt is settled. Insolvency exists when the member’s liabilities exceed the Full Market Value (FMV) of his assets, and proving insolvency will require the member to assemble a worksheet (provided in the current Publication 4681) which lists both his liabilities and the FMV of his assets at the time of the settlement, along with any helpful supporting documents (such as a copy of his credit report reflecting debt balances). IRS Form 982 should be filed along with that tax year’s return, with the “Discharge of Indebtedness to the Extent Insolvent” exception checked (Box 1b on the current Form 982).

To better illustrate the above, here are two examples:

1) Excluding part of amount canceled from income. The member and credit union want to settle a $12,000 unsecured loan debt for $7,000. This would result in the credit union issuing a 1099-C that reports a $5,000 debt cancellation. At the time of the settlement, the member has $30,000 in total liabilities (including the debt being settled) and $26,000 in total assets. Thus, the member is insolvent to the extent of $4,000 and would only have to report $1,000 ($5,000-$4,000) of debt cancellation as “Other” income on that year’s tax return.

2) Excluding entire amount canceled from income. The member and credit union want to settle a $12,000 unsecured loan debt for $7,000. This would result in the credit union issuing a 1099-C that reports a $5,000 debt cancellation. At the time of the settlement, the member has $30,000 in total liabilities (including the debt being settled) and $14,000 in assets. Thus, the member is insolvent to the extent of $16,000 and would not have to report any of the $5,000 debt cancellation as “Other” income on that year’s tax return.

Of course, members should always consult their tax advisor to make sure that Form 982 can be used in their particular circumstance. For credit unions, however, making their members aware of this form and the option it may present to them, has the potential to salvage mutually beneficial settlements that may otherwise not come to fruition.


 

[1] If a debt is secured, other rules and considerations will apply that are outside the scope of this article.

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