Tax Implications of Debt Settlement
September 16, 2008
Did you know that you might have to report part of your debt settlement as taxable income? You could owe federal taxes, and depending on where you live, state taxes as well.
Tax consequences are a common objection to debt settlement. Few consumers are aware of the tax implications. When you are suffering from financial hardship and unable to pay your bills, the last thing you expect to incur is debt to the IRS.
In general, the IRS considers debts that have been forgiven in the excess of $600 as taxable income. If you have settled with a creditor on a debt, they should send you a 1099-C tax form. This form will list the amount of forgiven debt and the interest.
Let us say you borrowed $10,000, and after paying back $6,000, you defaulted on the loan. After some time, you remain unable to pay the debt. The creditor agrees to forgive your remaining debt and sends you a 1099-C tax form. The IRS considers your taxable income to be $4,000 because you initially received $10,000 and only paid back $6,000. Additionally, you may have to pay taxes on any interest that is forgiven.
However, not all cancelled debts are regarded as taxable. Debt discharged in bankruptcy are not considered taxable.
If the amount of debt you owe is greater than your assets, meaning you are insolvent, the IRS does not require you to report the forgiven debt. But, you cannot exclude any amount of forgiven debt that is more than the amount by which you are insolvent.
Certain farm debts and non-recourse loans are also not regarded as taxable.
Certain student loan debts are also considered not taxable.
The laws are complicated and it is best to consult a professional to find out what your tax responsibilities are.
If you enjoyed this post, make sure you subscribe to my RSS feed!
Comments
Got something to say?
You must be logged in to post a comment.
