If you’re still in debt, you could be thinking about talking to your creditors about settling your debts for less than you owe. It’s important to have a complete picture of the financial impact debt settlement can induce including how can affect your taxes.
If you negotiated a settlement with your creditors, it can be looked at that you’re essentially “earning” money from your debt. Why? Here’s how it works: If you took out a loan for $10,000 and couldn’t pay it back, but negotiated with your creditors for them to accept $6,000 as full payment of your loan, you’ve pocketed $4,000 (the difference between how much you borrowed and how much you paid back). The IRS takes a close look at these kinds of loan repayments and factors them into your tax return.
At some point in the past, there probably was a loophole in U.S. tax laws that allowed for such ’savings’ to happen. The IRS can smell anything – well – taxable and got smart about these this money saving strategy. However, like many other loopholes in tax law, this one is closed for business.
As mentioned previously in the example above, settling credit card debt or any other debt for less than what is owed to the creditor will probably result the cardholder being held liable for the “profit” realized after paying off the reduced debt amount. It’s important to keep these records handy when filing your taxes after settling your debts.
Even though this may sound like a bad thing, it’s possible to still come out ahead after taxes. In the example above, the $4000 that was realized as a gain might be taxed at 30%, depending on one’s tax bracket. However, even when you add the $1200 tax, the total amount paid ($7200) is much less than what was paid to clear a $10,000 debt. That’s still a bargain in some books.
The debt settlement tax comes as a surprise to many people who don’t expect to owe taxes on their so-called profit or gain until the IRS conducts an audit. Don’t let it take you by surprise – it’s better to be prepared.
If you require more details on how to deal with this tax, please consult your CPA or another tax expert to ensure your finances are handled correctly in the eyes of the iRS.
About the Author: Sean Payne is a personal finance expert who has learned through trial and error (and a lot of advice) how to get out of debt. Discover how to avoid the debt settlement tax at Sean’s website.
Tags: Credit Card Debt, Credit Counselors, Credit Help, Debt Collection, Debt Consolidation, Debt Relief, FICO, Personal Finance
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If you’re still in debt, you could be thinking about talking to your creditors about settling your debts for less than you owe. It’s important to have a complete picture of the financial impact debt settlement can induce including how can affect your t…
Thanks for all your help and info!
I didn’t realize that people get taxed on the debt they settle. It makes settling debt into a balancing of both reducing debt as well as managing taxes to make sure that they debt settled doesn’t turn into to much taxes. It just goes to show that a good tax preparer is worth every penny.
Just wanna say thank you for the information you have shared. Just continue writing this kind of post. I will be your loyal reader. Thanks again.
Just wanna say thank you for the information you have shared. Just continue writing this kind of post. I will be your loyal reader. Thanks again.