November 25, 2020

You may want to file an amended tax return if you have already filed but need to make changes.  One reason is that taxpayers commonly go to their tax preparer to have their taxes filed without having all of the information or documentation that needs to be considered when filing. This type of situation can bring on a host of negative implications, such as increased balance. Or it can cause an audit. Neither of which you want to be dealing with after you have filed.

Why Amend a Tax Return?

To put it simply, a taxpayer or a business should file an amended tax filing if filing the amended tax return will help their bottom line. For example, filing incorrectly by overstating income, or forgetting to subtract deductions that would have lowered the taxable income. Another common reason is if you would like to change your filing status. This is especially important since the Tax Laws Jobs Act came into effect.  And finally, to correct error that has resulted in you owing more money. These are just a few, but there are many reasons why one would want to amend a tax return.

If you submitted a tax return that had a debt settlement amount listed as income, only to realize later that the debt was exempt, then the return can be amended and resubmitted to the IRS for processing. You can fill out a 1040X form or contact a tax expert to assist you in doing so.

How Do I Amend a Tax Return?

Unlike standard yearly tax returns, an amended return cannot be electronically filed. This means that you must fill out the form – a 1040X with the year that’s being amended clearly listed on the top – and mail it in. The IRS will review your amended return once they receive it.

The 1040X form needs to reflect all of the other information that you previously submitted that year, with the exceptions of the debt settlements or additional details that were wrongly included on it. The IRS looks at amended returns very closely, so make sure that you have everything correct or contact a tax expert for assistance when filling out the new return. You do not want to go through the process yet again.

How Far Back Can I Amend a Tax Return?

In most cases, you have three years to amend a submitted tax return. The clock starts on the date that you first submitted the return. For example, if you electronically sent in your return on April 1, 2018, then you have until April 1, 2021 in order to amend the return. If you incorrectly listed a debt settlement as income and therefore did not qualify for a tax return that year, then you can update the return and qualify for one. Keep in mind that the IRS will need to review the amended return in order to determine that everything is now correct.

When Is a Canceled Debt Excluded from Taxable Income?

With that said, debt settlements aren’t quite as simple as they sound, and some of them are exempt from being declared income. Plus, there’s the slightly confusing situation where you don’t receive a 1099-C after a debt is cancelled, yet have to track it, just in case it does count as income. Here are the main debt settlements that you won’t have to declare as income on your tax return:

  • Debt Cancelled Due to Bankruptcy – When you file for a chapter 7 bankruptcy and have all of your debts cancelled, you do not need to count them as income. Since people who file for chapter 7 often tend to be of low-income status and must meet a number of other qualifications, treating the debts that the bankruptcy discharges as income would only hurt them, not give them a chance to get back on their feet as bankruptcy intended.
  • Debt Cancelled Due to Insolvency – Someone who is insolvent, that is, they have more money in debts than they do income, can have debts cancelled by the creditor. For example, when someone owes $40,000, but only makes $30,000, they may qualify for an insolvency cancellation. This money doesn’t need to be declared on a tax return as income.
  • Cancellation of Real Business Property Debt – If you previously owed money on a business property, such as your warehouse or office building, and the debt is cancelled, either because you reached a settlement with the bank or lien holder, or for some other reason, that particular debt does not qualify as taxable income.

What Can I Do if I Paid Taxes on a Debt That Was Excluded?

Sometimes mistakes happen, and people pay taxes on a debt settlement that was supposed to be excluded. Instead of leaving this debt removed from your taxes altogether or filing it in a separate category, you mistakenly count it as income. As a result, your overall income will be higher and not offset by deductions. You may have made monetary payment to the IRS in order to clear up the debt before it became problematic, accrued fees and interest, or a tax lien was filed. Only now, it’s realized that the debt should have been excluded altogether.

In this case, the best course of action is to see a tax professional and have an amended return created. Since you have several years to amend a return after it’s submitted and processed, even if you already paid the amount due to the IRS on it, you can resubmit the return in its new, corrected form. Once the IRS has processed the return, they may return the money that you paid, either in full or partially, depending on the mistake and how much you owed (or did not owe) after it’s been corrected. As a result, the money may be refunded to you, even after you’ve made the payment.

How Can I Settle My Tax Debt?

If it turns out that you owe a tax debt due to a debt settlement, contacting the IRS to set up a payment plan as soon as possible is a responsible next step. After all, your tax debt is accruing interest and fines from the minute that your tax return is received and processed by the IRS without the payment included. Even if you feel as though you don’t owe the tax debt due to a wrongly included debt settlement, then the best thing to do is reach out to the IRS and file an amended return to correct the situation.

However, if you owe tax debt for another reason, such as having untaxed income that adds up to more then your deductions (this often happens to small business owners and independent contractors), then a payment plan or settlement with the IRS is the best option. Remember, you don’t want them to place a tax levy on your belongings or income, as those can take some time to remove once you have paid the back taxes that you owe the IRS.

Filing a correctly amended return to reduce your debt can be a complicated endeavor. If you have tax-related questions about receiving a debt settlement or are wondering if you can amend a return in order to remove an incorrectly reported debt settlement, the tax advisors at the Enterprise Consultants Group can answer your questions, discuss your rights, and provide actionable options. Please contact us online or at (800) 575-9284 today to schedule a free and confidential consultation to see how we can help you.

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