Forgiven Debts: The Hidden Tax Time Bomb That Could Kick Small Businesses While They’re Down

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Small businesses that stay out of bankruptcy but have some portion or all of their debts forgiven (excluding PPP debt) are in for a rude awakening come tax time next year. In a variety of circumstances, cancelled debt can be classified as taxable income for the debtor per the IRS. This, according to a new tax study titled Did The IRS Forget Non-PPP Debt? authored by Grassi & Co, a leading accounting and business firm based in New York, that was produced in collaboration with deBanked.

At face value, it would appear that taxpayers who have non-PPP debt canceled, forgiven or discharged during the COVID-19 crisis and do not meet any of the specific exclusions mentioned in the report, would be subject to tax on the cancelled debt as income.

This tax treatment, which pre-existed COVID-19, could be devastating in this era where the prevalence of debt forgiveness is likely to reach unprecedented levels.

money bombIn many cases this year, debt cancellation will be the direct result of government mandated shutdowns that were of no fault of the businesses themselves. Should they refrain from filing for bankruptcy and successfully negotiate a cancellation of some debt, it seems quite disastrous that the same government that shut them down might deliver a second blow by taxing the acts that enabled the businesses to survive.

One must also consider that a lender may just cancel some or all of a portion of a debt without any direct action of the debtor, with the end result being the same, a potential tax bill to the business on the cancelled portion.

It’s important to understand the various exclusions to the IRS guidelines that govern cancelled debt. The full report can be ACCESSED HERE.

Last modified: May 13, 2020
Sean Murray

Category: Loans

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