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A very large number of people find themselves owing thousands of dollars to credit card companies and as a result, searching for viable options to successfully eliminate their debt in order to avoid a bankruptcy filing. Debt settlement has become a very popular alternative to bankruptcy amongst scores of individuals especially since the bankruptcy laws changed back in October 2005. As you may know, debt settlement is a process which enables debtors (consumers) to negotiate a reduced pay-off balance (normally 50% or less) with their creditors. When the agreed-upon settlement amount is paid, the remaining balance is forgiven, and no further debt is owed.

When creditors agree to settle an account for less than what is actually owed, they are required by the IRS to report any forgiven debt over the amount of $600 on Form 1099. The potential of facing a tax liability resulting from debt settlement can be unnerving to a good many people, including consumers, as well as some debt counselors. On the other hand, an equal amount of people have difficulty understanding this train of thought, and feel that the possible tax consequences of debt settlement shouldnt play a major role in whether or not one should choose debt settlement to free themselves from debt.

If you should owe taxes on the amount of your forgiven debt, its simply due to the fact that you saved a significant sum of money. Because of this it seems that it would be common sense to realize that the total amount of money you paid to your creditor, in addition to the income tax liability, would still be a great deal less than what you would end up paying if you were to continue making the minimum monthly payments on your accounts each month. As a matter of fact, its more than likely that the interest you would end up paying to a creditor over a period of years would easily exceed the taxes for which you may be liable, as a result of settling your debt.

Theres also a strong likelihood that you may not be required to pay taxes on your forgiven debt if youre able to prove that you were insolvent at the time you settled your debts. In order to be classified as insolvent it is required that have a negative net worth, meaning your liabilities must exceed your assets.

Now, if this is not the case, and you dont qualify for an insolvent classification, obviously you may owe at least something to the IRS. If you believe this to be so, its important to talk with a tax professional prior to the April 15 tax deadline so that you may obtain proper advice pertaining to your particular situation. If you simply dont know where you stand regarding the insolvency rule, its a good idea to carefully review IRS Publication 908 for additional information.

In the end, its your bottom line that should matter most. If youre buried in debt and considering debt settlement to eliminate your financial struggles, the possibility of a tax liability shouldnt be a deterrent. You see, if your ultimate goal is to be debt-free, its crucial to do your homework so you can better understand that the positive end result of settling your debt may easily outweigh any taxes for which you may be liable.

Tags: Amount Of Money, Bankruptcy Filing, Bankruptcy Laws, Common Sense, Creditor, Creditors, Debt Counselors, Debt Settlement, Debtors, Form 1099, Income Tax Liability, Income Taxes, Irs, Likelihood, Matter Of Fact, Sum Of Money, Tax Consequences, Thousands Of Dollars, Train Of Thought, Viable Options

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Debt Settlement & Income Taxes What You Need To Know

Debt settlement has become a popular approach to resolving problem debts without having to file bankruptcy. With this approach, creditors agree to accept a portion of what you owe (usually around 50% or less) to settle the account, and the remaining balance is forgiven. This technique will certainly continue to grow in popularity now that the new bankruptcy law makes it tougher to fully discharge debts in a Chapter 7 bankruptcy.

As with anything, there is no free lunch, and creditors are required to report canceled debts to the IRS on Form 1099 (when the canceled balance is $600 or greater). Therefore, the possibility exists that you may owe taxes on the forgiven portion of the debt. For this reason, many financial writers and debt counselors are strongly critical of debt settlement, to the point where they actually recommend against it just because you might end up owing taxes. But the tax consequences of settling your debts are greatly over-emphasized, and this is a really just a minor issue at best.

First, even if you end up owing taxes on the canceled balances, that’s because you saved a bunch of money off your original debts. The total of what you paid the creditor, plus the taxes, will still be much less than what you owed to begin with. There is still a net savings. So it’s hard to understand why this is viewed as a problem in the first place!

Second, the great majority of people who settle their debts are not required to pay taxes on the forgiven part of the balance. That’s because of the “insolvency” rule, described in IRS Publication 908, “Bankruptcy Tax Guide.” Don’t let the title fool you. You don’t need to have filed a formal declaration of bankruptcy to take advantage of the insolvency rule.

Basically, “insolvent” means that you have a negative net worth — that is, you “owe” more than you “own.” As a consequence, most debtors do not have a tax liability on the canceled debts, simply because most debtors are insolvent! It usually comes down to home equity. If you have enough equity in a home (or other property) to outweigh the total of your liabilities (debts), then you have a positive net worth, and will likely have to pay taxes on the forgiven debt amounts. However, the majority of people in serious debt trouble have a negative net worth, and are therefore insolvent. The way it works is that you can offset the canceled debt up to the amount by which you were insolvent at the time you did the settlement.

Come tax time, be sure to get professional tax advice specific to your situation. Also, be sure to read the section in IRS Publication 908 on “reduction of tax attributes,” which requires people using the insolvency rule to reduce their basis in such things as rental property, loss carryovers, etc. Most of that probably won’t apply to you, but again, get specific advice before winging it.

So, the message is, relax about paying taxes on canceled debt balances. That should be the least of your concerns if you’re upside down financially. Don’t let the misguided criticisms of financial writers (who haven’t done their homework) discourage you from looking into one of the most popular and flexible options for achieving debt-freedom.

Tags: Bankruptcy Tax, Chapter 7 Bankruptcy, Creditor, Creditors, Debt Counselors, Debt Settlement, Debtors, File Bankruptcy, Financial Writers, Form 1099, Formal Declaration, Income Taxes, Insolvency, Irs Publication, Net Worth, New Bankruptcy Law, Problem Debts, Tax Consequences, Tax Liability, There Is No Free Lunch

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