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Insolvency means the inability to pay one’s debts as they fall due. Usually used in Business terms, insolvency refers to the inability for a company to pay off its debts.

Generally, debtors take on debts to creditors under state law. When they become insolvent, the seek relief from those debts under the federal Bankruptcy Code. The U.S. Constitution authorizes Congress to pass “uniform Laws on the subject of Bankruptcies.” In doing so, the Congress set up special bankruptcy courts as adjunct to regulsr U.S. District Courts. The bankruptcy courts handle most bankruptcy cases.

At a high level, there are two kinds of bankruptcy cases: voluntary ones, where the debtor files to get protection from the bakruptcy court, and involuntary ones, where the creditor files to get help from the bankruptcy court in recovering money owed to it. When a bankruptcy case starts, the court issues an “automatic stay” that prohibits any other court actions trying to recover money from the debtor.

With foreclosure and short sales continuing to mount, taxpayers need to be alert to the tax issues associated with these transactions. The general rule regarding debt cancellation is that it is a taxable event. However, there are some exceptions that people need to make sure that they are aware of. Many of the debt cancellation exclusions involve bankruptcy, the Mortgage Forgiveness Debt Relief Act, the insolvency provision, and certain farm and other business indebtedness.

The promoters of the bankrupt company too would become insolvent. No bank or financial institution would lend them any kind of assistance in future if they wish to start a new business. Thus, every company should take care and seek for help at the right time if they think they would soon become insolvent. The auditors play a key role in keeping the company in good health and preventing it from going bankrupt.

Determining whether or not you are insolvent or if you qualify for any of the other debt cancellation exclusions can be very challenging for the average person. It requires careful study of state and federal tax laws and accurate calculations.