Debts Forgiven, Taxes Increased

And no, the tax obligation doesn't go away if the creditor fails to send you the form at the end of the tax year. Even if you didn't get a 1099, it's possible the creditor sent one to the IRS. The settled debt should be reported on your 1040 tax form.

You also may have to pay income tax on any interest that is forgiven. For more details about what interest is taxable, read IRS Publication 525 (skip to the section on canceled debt).

But some canceled debt is not considered taxable income. For example, the cancellations of qualified farm debt, certain student loans and debt discharged in a Chapter 11 bankruptcy are not taxable. In the case of student loan debt, if your loan is forgiven in part or full, you won't have to pay those taxes if you promised to work for a certain period of time in certain professions (and you kept that obligation).

There's also a provision of the law that excludes canceled debt if you're insolvent, meaning your liabilities exceed the fair market value of your assets. But trust me, the insolvency exception is complicated and you should seek professional help.

You may not have to include in your taxable income a canceled debt if your principal residence was damaged by recent hurricanes. This relief applies to debt discharged between Aug. 25, 2005, and Jan. 1, 2007. For more details, see Publication 4492 "Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma."

There are two other IRS publications you can read to find out more about cancellation of debt: IRS Publication 17 "Your Federal Income Tax" (go to Page 12) and IRS Publication 908 "Bankruptcy Tax Guide" (skip to Page 21).

For many debtors, having to pay income tax on canceled debt seems so unfair, especially if they've suffered a financial hardship. But is this tax rule that unjust?

When you get a loan to buy a home or car, or use a credit card to pay for goods and services, that capital isn't considered income because you have to pay it back.

Hardship or not, didn't you live in the house? Didn't you drive the car? Didn't you use, wear or eat the items purchased on credit?

If you don't pay back the loans, haven't you enriched yourself at the expense of the creditor?

· On the air: Michelle Singletary appears on Washington Post Radio (107.7 FM, 1500 AM) at 6:20 a.m. Thursdays. She also discusses personal finance Tuesdays on NPR's "Day to Day" program and online athttp://www.npr.org.

· By mail: Readers can write to her at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

· By e-mail:singletarym@washpost.com.

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