Insolvency (Beyond the scope of VITA/TCE)

Insolvency is a condition in which the fair market value (FMV) of all assets is less than one's liabilities. The amount or level of insolvency is expressed as a negative net worth.

For purposes of determining insolvency, assets include the value of everything owned (including assets that serve as collateral for debt and exempt assets which are beyond the reach of creditors under the law, such as an interest in a pension plan and the value of a retirement account).

Liabilities are amounts owed and include:

• The entire amount of recourse debts
• The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt
• The amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the property subject to the debt is forgiven

If the taxpayer had nonbusiness credit card debt canceled, all or part of the debt may be excluded if the cancellation occurred in bankruptcy, or if the taxpayer was insolvent immediately before the cancellation. If any of these situations apply to the taxpayer, they will need to be referred to a professional tax preparer. These situations are beyond the scope of VITA/TCE. See IRS Publication 4681 for more information.

Click here to view Publication 4731, the Screening Sheet for Form 1099-C, Cancellation of Debt, which provides step-by-step guidance for the volunteer tax return preparer to determine if the cancellation of debt is within scope. Part II addresses credit card debt.