If you have worked out a deal with a creditor to settle your debt are you aware that there may be tax implications? Many creditors during debt settlement negotiations fail to let consumers know that once their debt is settled, they could be hit with a hefty tax bill. Here is what you need to know if you already have or plan to settle your debt.
Debt Settlement Is Considered Income
The IRS considers any debt that you have settled over the amount of $600.00 as taxable income. Therefore, if you settle $10,000.00 worth of debt for the cost of $5,000.00, the amount of debt that was forgiven ($5,000.00) is considered taxable income for the tax year in which the debt was settled. After the debt has been settled, your creditors are responsible for reporting the forgiven amount as income to the IRS and must issue you a 1099-C form. The 1099-C is a cancellation of debt IRS form that must be filed with your yearend federal tax return.
Are There Any Circumstances Where You Won’t Owe Tax Dollars On Settled Debt?
Under certain circumstances you may be entitled to an exemption or a reduction in taxable income incurred from a debt settlement. If you receive a 1099-S form due to a debt settlement you will want to take immediate action, work with a tax specialist who understands the laws and find out what exemptions or reductions you might qualify for.
An exemption or reduction may be granted in the case of debts forgiven during a bankruptcy and for debts forgiven to an individual who is insolvent, meaning they have liabilities above and beyond their assets. Additionally, the IRS currently has a special program in place to help homeowners who were foreclosed on as a result of the housing market crisis. For tax years 2007 to 2012 these homeowners may qualify for an exemption or a reduced tax liability.
In order to qualify for a reduction or an exemption, tax payers must file IRS form 982 along with their 1099-C form when they file their federal tax return.
What Else You Need To Know About Debt Settlement And Tax Liability
Many people are unaware that when they settled their debt there would be tax implications. Whether you knew ahead of time or not, if you do not qualify for a tax exemption you will need to pay taxes on the amount of debt you had cancelled.
If you are considering a debt settlement and are uncertain whether or not you should enter a debt settlement agreement because of possible tax liabilities, you may want to speak with a tax specialist or a debt settlement expert who is familiar with how the process works. In most cases you are still probably better off settling your debt.