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Home > Finance > Taxes > Debt Settlement – What Ab...
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Debt Settlement – What About The Income Taxes?
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If debt seems to be on your mind quite often in recent months, there’s
a high probability that you’ve looked into your options and found that
debt settlement is growing in popularity as an alternative to
bankruptcy. This is especially true since the new bankruptcy law went
into effect back in October 2005. Debt settlement, as you may know, is
a process by which creditors agree to accept less than the full balance
owed (usually around 50% or less) to settle an account. The remaining
balance is then forgiven and no further money is owed.
When a creditor agrees to settle an account for less than the full
balance, they are required by the IRS to report the canceled debt on
Form 1099, if the amount of the forgiven debt is $600 or greater. The
possibility of tax consequences as a result of debt settlement seems to
be unsettling to many people, including some consumers and debt
counselors. When you look at the larger picture, however, you’ll better
understand why the tax consequences of debt settlement shouldn’t even
be a major consideration.
When individuals are required to pay taxes on the amount of the
canceled debt it’s because they saved a significant amount of money,
right? It seems that it should be common sense to realize that the
total amount paid to the creditor, in addition to the taxes would still
be much less than what you would end up paying if you were to continue
making the minimum monthly payments each month. As a matter of fact,
it’s highly likely that the interest paid to a creditor over a period
of years would easily exceed the taxes for which you may be liable as a
result of settling your debt.
There’s also a good possibility that you may not be required to pay
taxes on your forgiven debt if you can prove that you were “insolvent”
at the time you settled your debt(s). In order to be classified as
insolvent you need to have a negative net worth. In other words, you
would owe more money than you’re actually worth and your liabilities
would exceed your assets.
If this is not the case and you’re not classified as insolvent at the
time of any settlement of debt, then obviously you may owe at least
something to the IRS. If this is the case then it’s important to speak
with a tax professional as the April 15 tax deadline nears so that you
may get advice regarding your particular situation. If you’re not quite
sure where you stand regarding the insolvency rule take a look at IRS
Publication 908 for additional information.
The bottom line is your bottom line. If you’re in debt and considering
debt settlement as an option, the possible tax consequences shouldn’t
play a major role in your decision. Your ultimate goal is to be
debt-free. If you do your homework you’ll see the positive results of
resolving your debt will likely outweigh any tax liability which you
may have and your bottom line will prove it.
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