|About Debt Settlement
Title: Debt Settlement. What About the Income Taxes?
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
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
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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