Insolvent individuals not filing for bankruptcy recognize cancellation of debt as income. The re- portable amount is the lesser of:
• The amount of indebtedness forgiven or dis- charged; or
• The taxpayer's net worth as calculated using generally accepted accounting principals (GAAP) immediately after the cancellation. If an insolvent individual is not rendered sol- vent by the cancellation of debt, no income is recognized.
Solvent individuals would report the amount of indebtedness forgiven or discharged as income.
The basis of an insolvent debtor's property must be reduced, but not below its fair market value. Basis reductions for amounts canceled shall be allocated in any manner that has the effect of re- ducing the difference between the fair market value and the adjusted basis of the properties.
Individuals Who File for Bankruptcy
Unless the case is dismissed, an individual bank- ruptcy filed under Chapter 7, 11 or 12 of the Bankruptcy Act leads to the creation of a bank- ruptcy estate, and no income shall be considered to have been realized by reason of discharge of indebtedness under bankruptcy laws.
If cancellation of debt is excluded from income based on the insolvency or bankruptcy exclu- sions, the taxpayer must reduce his or her tax attributes, including his or her adjusted basis in property.
Income from cancellation of debt is taxable to Pennsylvania when:
• Under GAAP, the debt forgiven was consid- ered a liability
• Where the debt forgiven constitutes a quid pro quo or incentive that would be taxable under PA personal income tax regulations if it had been paid to the debtor in cash or in property
Class of Income
• If debt forgiveness relates to an
employee/employer relationship, it is re- ported as compensation.
• If debt forgiveness relates to business, pro- fession or farm income, it is reported in that class.
• If debt forgiveness relates to the sale, dis- continuation or abandonment of a business or segment thereof, it is reported as gain on the sale of property.
• If the debt forgiveness relates to rent, roy- alty, patent or copyright income, it is reported in that class.
For more detailed rules on cancellation of debt, please refer to Personal Income Tax Bulletins 2009-2 through 2009-6 on the department’s website.
NON-EMPLOYEE COMPENSATION
Reimbursable expenses, even if not reimbursed, may not be deducted.
Unreimbursable expenses incurred for realizing non-employee compensation (e.g. executor fees, administrator fees, etc.) may be claimed on PA Schedule UE as long as:
• The agreement contemplates that a portion of the director/executor’s fee is intended to reimburse the director/executor for his or her actual expenses; and
• The expenses are ordinary, actual, reason- able and necessary (i.e. no commuting or personal expenses may be deducted).
CAFETERIA PLANS
Cafeteria plans are federal plans pursuant to In- ternal Revenue Code (IRC) Section 125 under which employers sponsor benefit packages that offer employees choices between cash and quali- fied benefits. If the employees choose cash, the cash amounts are included in taxable compensa- tion. If the employees choose qualified benefits, the values of the benefits are not included in gross income. Qualifying benefits include:
• Accident coverage • Health coverage
• Group-term life insurance coverage • Dependent care programs
• Certain employer payments for educational expenses
• On-site athletic facilities provided and oper- ated by the employer
• A profit-sharing or stock bonus plan or rural cooperative plan as defined in IRC Section 401(k)(7) that includes a qualified cash or deferred arrangement as defined in IRC Section 401(k)(2).
If a taxpayer’s employer maintains a federally qualified cafeteria plan pursuant to IRC Section 125, certain amounts deducted from the taxpayer’s salary (e.g., health/accident insur- ance) are not subject to PA personal income tax to the extent excluded for federal purposes.
Employer-provided flex dollars that an employee must use to pay for PA-exempt benefits, such as health insurance or life insurance, are excludable from income taxation. Employee contributions to a qualified IRC Section 125 plan for coverage for hospitalization, sickness, disability or death, sup- plemental unemployment benefits or strike benefits -- like employer contributions -- are ex- empt, but only to the extent they are exempt for federal income tax purposes. If an employer has an employee benefit plan that is not a qualified IRC Section 125 plan, employee contributions, even for the same kinds of coverage, are not ex- cludable from PA taxable compensation.
Employee payments and contributions for other benefits, including dependent care and contribu- tions to an IRC Section 401 plan, are not
excludable from PA taxable compensation. If the employer’s plan provides life insurance coverage that includes coverage for an employee’s de- pendent child and the employee pays a portion of the premium for that coverage, that portion of the employee’s payment is not excludable. For PA personal income tax purposes, all benefits other than for death, disability, hospitalization and sickness are taxable.