Cancellation Of Debt (COD): Tax Debt Cancellation

Cancellation of Debt (COD) Income

Taxation in the United States

Taxpayers in the United States may have tax consequences when debt is cancelled. This is commonly known as COD (Cancellation of Debt) Income. According to the Internal Revenue Code, the discharge of indebtedness must be included in a taxpayer's gross income.

There are exceptions to this rule, however, so a careful examination of one's COD income is important to determine any potential tax consequences.

Policy Reasons Behind COD Income Exclusions
First, it is difficult to collect tax from insolvent taxpayers. The bankruptcy and the insolvency provisions defer the tax to a time when taxpayer is able to pay.

Insolvency

A taxpayer is insolvent when their total liabilities exceed the fair market value of assets. For example, if a taxpayer has $100,000 in liabilities, but only $50,000 in assets, they are considered insolvent under the Internal Revenue Code.

Therefore, a cancellation of a $20,000 debt will not need to be reported as gross income. However, if a debt of $60,000 was cancelled, the taxpayer will have $10,000 in gross income because their total liabilities no longer exceed their total assets (cancelling $60,000 in debt means the taxpayer now has only $40,000 in liabilities).

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