How Debt Settlement Will Affect Your Taxes

Have you recently or are you planning on going through a debt settlement? A debt settlement can greatly benefit you, leaving you with lower payments and less debt. But did you know that a debt settlement affects your taxes? If you don’t completely understand how a debt settlement will affect your taxes, keep reading.

DEBT SETTLEMENT

A debt settlement occurs between a lender and a borrower when the borrower is unable to pay the original amount of debt. The lender agrees to lower the payments and debt in order to make it possible for the lender to keep paying. For instance, if you have a $5,000 credit card bill that you are unable to pay, the credit card company may agree under a debt settlement to reduce the amount owed to $3,000 and lower the monthly payments. As the borrower, you come out $2,000 ahead because you now owe $2,000 less than you previously did. This is beneficial in many ways, but it is not without consequence. For one, a debt settlement will go against your credit score. Also, you must report information about any debt settlements on your tax return. The amount forgiven, such as the $2,000 in the previous example, mu

DEBT SETTLEMENT TAXES

Information about debt settlements must be reported on your tax return. This is because the amount forgiven, such as the $2,000 in the example above, is taxed as income since you ‘gained’ $2,000 in the transaction by no longer having to pay it back. The $2,000 would simply be added to your gross income for the year. So, for example, if you made $30,000 in the same year you went through a debt settlement where $2,000 was forgiven, then your gross income, which is used to calculate how much income taxes you owe, would be $32,000 ($30,000 + $2,000).

The information about any debt settlements needed to file your taxes will usually be provided to you at the end of the year by the lender on a tax document known as a 1099-C.

EXCEPTIONS

In some cases, the amount of debt forgiven in a debt settlement may not need to be reported as income. Debt forgiven as part of a bankruptcy is not considered income. Indebtedness due to qualified farm expenses or business property losses may not be taxed. Debt forgiveness treated as a gift may not have to be reported (for instance, Mom says, “Don’t worry about that $10,000 you owe me, dear”). If you are insolvent at the time of the debt settlement, meaning that your total debts exceeded your total assets, then the amount of debt forgiven that is treated as income cannot exceed your total assets. For instance, if you are forgiven $10,000 but are only worth $4,000, then only $4,000 of the $10,000 forgiven is considered income.

This guest article was contributed by Jane Sanders from Debt Management. You can find more information about debt settlement on her site.

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