Hurricane Katrina: Forgiven Debt

If taxpayers have personal debt (such as from a mortgage or credit card) forgiven from Aug. 25, 2005 to Dec. 31, 2006, they may not have to pay Federal income tax on the debt forgiven. Under Katrina Emergency Tax Relief Act of 2005 Section 401 and JCX-69-05 (9/22/05), p. 28, for the forgiven debt to qualify for this special treatment, both of the following must be true:

• The creditor forgiving the debt is a government agency or a financial institution (e.g., a bank or credit card company).

• The taxpayer was living in a Federal Emergency Management Agency (FEMA)-designated individual assistance area on Aug. 25, 2005; see Exhibit 1.

If taxpayers were living in an area that FEMA designated only for public assistance (see Exhibit 2), their forgiven debt might still qualify, if both of the following are true:

• They suffered an economic loss.

• The creditor forgiving the debt is a government agency or financial institution (e.g., a bank or credit card company).

This tax treatment does not apply to personal debt on property located outside the Hurricane Katrina disaster area (see Exhibit 3). If taxpayers have such property and the debt on that property is forgiven, they will have to pay Federal income tax on the forgiven debt.

Caveat: Special tax rules apply when Federal income tax is not paid on forgiven debt, which may have an effect on taxpayers Federal income tax return.

From Linda Gurene, San Antonio, TX