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What are the Tax Consequences of Settling Credit Card Debt?

On Behalf of | Apr 1, 2019 | Chapter 7 Bankruptcy

If you are looking for an alternative to filing for bankruptcy protection, you may be considering settling your debt.  In debt settlement, you negotiate with your lender(s) to pay a smaller amount than what is owed as payment in full. While this may seem like the perfect solution to your money troubles, debt settlement does not come without its disadvantages.

Credit Card Debt Settlement Creates Taxable Income

When you settle a credit card debt for less than the full amount, or a creditor writes off debt that you owe, the lender or debt buyer may be required to file Form 1099-C, Cancellation of Debt.  This form must be filed if the creditor has canceled $600 or more of a debt’s principal (the amount not attributable to interest or fees). Because you no longer must pay the debt in full, the IRS treats the forgiven amount as income.

You may need to pay taxes on that forgiven amount. Typically, the tax debt is less than the amount of the forgiven debt, so you still may come out ahead. However, if you are not prepared to pay your taxes, it can be devastating. Facing your tax debt in addition to your medical bills, credit card debt and other loans can once again make you feel like you are drowning in your debt.

Avoid Paying Taxes on the Forgiven Debt

Bankruptcy and insolvency

There are two circumstances under which you may not need to pay taxes on the amount that’s wiped out in a credit card debt settlement.

Under Internal Revenue Code Section 108(a), you do not need to include the forgiven amount of the credit card debt in your gross income if the discharge occurs in a bankruptcy case or you were insolvent before the creditor agreed to settle or write off the debt. https://www.irs.gov/taxtopics/tc431

In a bankruptcy you can discharge (eliminate) thousands of dollars of debt without the IRS considering it as income. This is why bankruptcy is often referred to as a “fresh start” – you can emerge from your case truly debt-free.

We Can Help

If you are considering debt settlement, it is essential that you confer with a professional who can explain the pros and cons of the process. In certain situations, the tax consequences of having your debt forgiven can be eliminated or reduced. If you are interested in learning how filing a bankruptcy case can benefit you, contact Levitt & Slafkes, P.C., at 973-323-2953. You can also reach us by filling out our online form. We represent debtors in Chapter 7, Chapter 13 and Chapter 11 filings. Let us help you get the fresh financial start you need today.

We are proudly designated as a debt relief agency by an Act of Congress.  We have proudly assisted consumers in filing for Bankruptcy Relief for over 30 years. The information on this website and blogs is for general information purposes only.  Nothing should be taken as legal advice for any individual case or situation.