Fix the Tax Code Friday is back! This is your chance to sound off about tax policy – and propose how you would fix the Tax Code if you were in charge…
One of the heavily criticized pieces of the economic bailout package is the extension of the debt forgiveness exemptions for mortgage cancellations. Here’s how it works: traditionally, debt that is forgiven is taxable to the recipient as income to the extent of the forgiven debt. For example, if I owe the bank $1000 and I only pay $100 and the bank “forgives” the remainder, that $900 difference is taxable to me as income.
The idea behind treating forgiven debt as income is that not having to pay a debt that is owed is sort of like receiving a check for that amount. That $900 in the example above? It was a liability on my balance sheet which would have been paid off with income (or other assets). Moving it to “zero” has to be accounted for somehow; the answer, for tax and accounting purposes is to treat the forgiven debt as if I had received a check when the debt was wiped clean.
That was the traditional rule. However, to counter the growing numbers of house foreclosures and subsequent tax problems which resulted, Congress has exempted certain debt forgiveness as a result of mortgage cancellations from inclusion in income. This has relieved some taxpayers, who felt that the tax provisions punished them twice, and angered others, who question why former homeowners are getting a break for making what was perceived to be a poor decision in the first place. Other taxpayers also question why the exemption didn’t extend to other personal debt, like credit cards and personal loans, that were forgiven as a result of nonpayment.
So today’s Fix the Tax Code Friday question is a two-parter:
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