Settling Credit Card Debt & Income Taxes – What You Need To Know
Debt settlement has turned into a common solution to fixing problem debts without having the need to file bankruptcy. Using this approach, creditors agree to take a piece of what you owe (usually about 50% or less) to settle the account, and the left over amount is pardoned. This technique will certainly go on to build in popularity now that the new bankruptcy law makes it a bother to fully discharge debts in a Chapter 7 bankruptcy.
As with most anything, there is no free ride, and creditors have to report canceled debts to the IRS on Form 1099 (when the canceled balance is $600 or greater). As a result, the chance exists that you may owe taxes on the excused portion of the debt. For this reason, a lot of financial writers and debt counselors are strongly critical of debt settlement, to the point where they actually recommend against it just because you may end up paying taxes. Although the tax consequences of settling your debts are highly over-eggagerated, and this is a really just a minor issue at best.
First off, even if you end up owing taxes on the canceled balances, that is because you saved a lot of money off your inital debts. The total of what you paid the creditor, plus the taxes, will still be much momumentally less than what you owed to begin with. There is still a net savings. So it is problematic to understand why this is taken as a problem in the first place!
Second, the big majority of people who settle their debts are not required to pay taxes on the pardoned portion of the balance. That’s due to of the “insolvency” rule, described in IRS Publication 908, “Bankruptcy Tax Guide.” Do not let the title fool you. You do not need to have already filed a formal declaration of bankruptcy to take use of the insolvency rule.
Basically, “insolvent” means that you have a negative net worth — that’s, you “owe” more than you “own.” As a consequence, many debtors don’t have a tax liability on the canceled debts, clearly due to most debtors are insolvent! It for the most part comes down on home equity. If you have sufficient equity in a home (or other property) to override the total of your liabilities (debts), then you have a positive net worth, and will likely have to pay taxes on the forgiven debt amounts.
When it comes to tax time, be sure to get professional tax advice specific to your situation. Also, make sure to read the section in IRS Publication 908 on “reduction of tax attributes,” which requires people using the insolvency rule to lower their basis in such things as rental property, loss carryovers, etc. Most of that probably won’t apply to you, but again, get specific advice before winging it.
Thank you for reading my article. If you would like more information on the subject please visit: Settling Credit Card Debt
Related Posts
Tags
Share This
Recent Comments