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Preparing an Insolvency Worksheet: A Legal Guide

A business executive going through her financial documents before putting together an insolvency worksheet for the IRS.

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There are few experiences in life more stressful than facing ‘insolvency‘ that moment that you realize you have nothing more to your name than letters. You’re probably asking yourself, How could this happen to me? but the situation may not be as dire as you think. Before you start thinking of all the possible negative outcomes, it may help to get a better handle on the actual numbers you’re dealing with.

Preparing an insolvency worksheet will help spell out the reality of the situation so that you can move beyond insolvency in your life. Using an IRS insolvency worksheet can be a sober reckoning, but it’s also a good foundation to make plans on how to bounce back. Here’s a look at what insolvency means and how you can put pen to paper to get you through it.

What Is Insolvency?

According to the IRS, a person is insolvent when their total liabilities outweigh their total assets. There are some benefits to declaring insolvency with the IRS. When a financial institute or debt collector cancels some or all of the debt you owe, you will be issued a 1099-C. This will reflect the amount of money that was canceled or settled. Unfortunately, the IRS will consider any money reported on a 1099-C as a form of taxable income unless you can prove that it was insolvency during the time that it was canceled.

Here, the debt that has been canceled can be excluded because of insolvency from income under an IRS “insolvency exclusion.” This debt can also possibly be excluded in Title 11 bankruptcy exclusion or if the discharge dealt with real property from a business or farmland. If you believe you might qualify for any of the above exceptions for insolvency, be sure to review IRS Form 982.

How Do I Know If I Am Insolvent?

With respect to the IRS, it’s essential to discern between recurring debt difficulties and creeping insolvency so that you can address the problem properly. Insolvency typically occurs in one of two ways:

  • Asset Insolvency. When your total liabilities exceed your total assets.
  • Income Insolvency. When you can’t sustain cash flow so you can’t pay your debts as they come due (even if you’re keeping up with your basic debt payments, you might still be deemed insolvent under this scenario)

As an example of asset insolvency, let’s say someone’s assets include a car (worth $10,000) and a home (worth $200,000) and they have total debts in excess of $250,000. In this case, that individual is insolvent by $40,000 because their total debts of $250,000 exceeded their cumulative assets of $210,000. If a creditor you owed chooses to discharge $20,000 in debt owed, then because of the insolvency exclusion, that $20,000, which is normally taxable, is no longer taxable as income.

If you believe you can make your way out of debt, then you should consider testing that out to determine if you can remain solvent in the coming months. However, here are some telltale signs that there might be more problems afoot:

  • You use a credit card to pay for everyday expenses
  • You have maxed out your credit cards and can’t secure alternative funding sources
  • You use one credit card to pay for another
  • You can’t keep up with the minimum repayment options for the loans you have

What Is an IRS Insolvency Worksheet?

An insolvency worksheet helps you to determine the degree to which you are insolvent. Specifically, it tallies and compares your liabilities to your assets to make the determination of whether you are actually insolvent and, if so, to what extent.

How to Complete an IRS Insolvency Worksheet

First, prepare a list of all of your assets and indicate the fair market value for each. An asset is considered a valuable item that you can sell for cash. Assets can include your car, your home, jewelry, or other valuables. You should also make a list of all of your liabilities. Liabilities include any additional debt that you might owe.

Finally, you need to create a financial statement that compares your liabilities to your assets. Ideally, you want the table you create to demonstrate the fact that your liabilities in dollars exceed the fair market value of all of your assets.

This insolvency worksheet must be created at the time you receive the debt cancellation or the settlement. The only way that the IRS is going to deem you insolvent is if you complete the table as soon as you receive the 1099-C. In the event that you are insolvent, you are not required to file your 1099-C as an income.

Unsure How an Insolvency Worksheet Might Affect Your Tax Situation?

If you don’t yet know whether you’re insolvent or not, or whether there may be other tax laws that can benefit you, consider getting an initial legal review of your situation today.

Disclaimer

This article contains general legal information but does not constitute professional legal advice for your particular situation. The Law Dictionary is not a law firm, and this page does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

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