I’ve always assumed that California law excluded from income debt forgiven in bankruptcy, just as federal tax law does.
When a client asked me to confirm that the treatment was the same, I realized that this was one of those things I had just assumed. As a lawyer, I ought to know the danger present in “assume”.
So I looked it up. Bingo. California Revenue & Taxation Code 17131 includes IRC 108 among the federal provisions that are the same in California tax law. (There are too few of those places where the two are the same, for my tastes. But that’s another rant.)
Cancellation of debt income is one of those gotcha’s that lurk, undiscussed, in debt settlement arrangements. The tax system treats the forgiveness or cancellation of an obligation to be the same as if you had received the amount forgiven in cash! It’s taxable income, unless you qualify for one of the exceptions.
Bankruptcy is an exception to the rule that debt cancelled equals taxable income. Debt discharged in bankruptcy is eliminated “in a Title 11 case.”
CAUTION California law on exclusion of debt forgiven in a foreclosure of a home IS NOT exactly the same as federal law. At minimum, the amounts of cancelled debt differ.
Get tax advice from an experienced tax professional. Asking your realtor is not good enough.
Image courtesy of YIM Hafiz
Let me confirm what you are saying: debt discharged in bankruptcy is not taxable income per California law, but that cancellation of debt arising out of foreclosure is treated differently in California verses federal law. Well, you motivate me to check the law in my own state of Massachusetts.