Should Possible Tax Ramifications Determine if Debt Settlement is Right For You?

Are you considering debt settlement as an option to tackle an ever increasing amount of debt? If your best attempts to maintain minimum payments and keep your credit score out of the dump are failing and you feel you are running out of options, debt settlement can provide a road to real debt relief. There are many pros and cons to consider before enrolling in a debt settlement program or trying to negotiate with your creditors on your own.

One of the issues that pops up everywhere debt settlement is discussed is the possible tax ramifications of any “forgiven” debt resulting from a settlement. While it is true that debt settlement could have negative tax effects -should that be a determining factor when deciding if it is right for you?

What is debt settlement?

Before choosing debt settlement as a way to get out from under an overwhelming debt load, you must first understand what debt settlement is and if it is the right choice for you. In short-debt settlement is a debt reduction option available to people who have a high level of debt (normally $10,000 or more) and have already or are on the verge of not being able to make even the minimum payments.

If you no longer have the ability to repay your debt and other debt reduction options such as credit counseling or debt consolidation are no longer feasible options to consider, debt settlement may save you from filing for bankruptcy.

You can find a detailed explanation of how the process works here, but the gist of the process involves “banking” money (either on your own or using a third party financial institution) to use in future settlements or negotiations with creditors.

Unfortunately in most cases in order to bank money and put yourself in a position to negotiate your debt you will have to stop making payments on your accounts which will have negative affects on your credit score in addition to the emotional stress of dealing with debt collection tactics as you default on your accounts.

Where do the tax ramifications come into play?

The ultimate goal of the debt settlement process is to be able to negotiate with your creditors a lump sum payment which is less than the total amount of debt owed. While this process can successfully reduce debt by up to 50% creditors are required to report canceled debts (higher than $600) to the IRS. What does this mean to you? The possibility exists that you may end up owing taxes on the forgiven part of your debt.

Many opponents of debt settlement use this possibility of paying taxes on forgiven debt as a leading reason to dissuade people from taking this route. What these opponents fail to mention is the fact that in many cases you are not required to pay taxes on canceled debt due to the IRS’s insolvency rule. You do not have to file bankruptcy to prove you are insolvent or unable to pay back your debt. Another thing to consider is even if you are somehow required to pay taxes on forgiven debt you will likely still come out ahead since the negotiated amount plus taxes will be far less than the amount you originally owed.

Once you have taken all the pros and cons of debt settlement into consideration you are in a better position to determine if this is the right process for you and your financial situation. If you are really in a position to consider settlement as an option the most important thing is taking action to get out from under the mountain of debt you are currently contending with. Once you actively begin reducing your debt you can then truly focus on achieving financial freedom.

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