When Youve Got Taxable Income But No Cash By Forbes To the person on the street, the phrase “for tax purposes” sounds artificial, if not ridiculous. Even Jerry Seinfeld, in his eponymous television series, poked fun at it. Still, it’s a phrase ordinary taxpayers need to pay attention to. For example, take the notion of “constructive receipt” of income for tax purposes. A variety of events can give you taxable income this year even though you’ve seen no cash. Here are the most common ones you may encounter: Partnerships, LLCs and S Corporations Partnerships, limited liability companies (LLCs) and S corporations are all what’s known as “pass-through” entitles. That means they are generally not taxed themselves, as C corporations are. Rather, their owners are taxed. Each owner receives a Form K-1 that reports his or her appropriate share of the income (or loss) even if that income is retained by the business and not distributed to the owners. You are generally obligated to report on your tax return the amount attributed to you on Form K-1. Whether you received any payout is really irrelevant to the tax question. Note that the Internal Revenue Service matches K-1s against individual tax returns. So if you receive what you believe is an incorrect K-1, don’t ignore it. Try to get the issuer to correct it–as you would if a bank or broker sent you an incorrect 1099. Cancellation of Debt Income Another category where you can have income despite an absence of cash involves a discharge of debt (also called cancellation of debt or “COD” income). This has long been one of the more confusing and obscure parts of the tax law. But in the current recession, many more taxpayers have become painfully aware of it. If you are solvent and are relieved of the obligation to repay a $500,000 debt (your debt is forgiven), the tax law is clear that you’ve just received $500,000 in taxable income. In most cases, lenders are required to issue a Form 1099-C reporting this COD income to ensure you don’t omit it from your tax return. But don’t assume that just because you receive a 1099 you have taxable income–in certain circumstances, you can avoid recognizing this income, and the lender doesn’t necessarily know if you’re in one of those circumstances. The rules are complex and have been recently changed. But there are a few key exceptions to be aware of: Debts forgiven while you’re in bankruptcy–or if not in bankruptcy when you are technically insolvent with more debt than assets–don’t count as income. In addition, the Mortgage Debt Relief Act of 2007 generally allows you to exclude from income debt forgiven on your principal residence if the debt is wiped out as part of a mortgage restructuring or foreclosure that takes place between 2007 and 2012. Plus, you don’t have to be broke to take advantage of this exception.
Posted on: Thu, 20 Nov 2014 17:40:40 +0000
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