Debt settlement has become a well-known method of resolving problem debts without needing to file bankruptcy. With this approach, creditors consent to accept a part of what you owe (usually about 50% or less) to pay the account, and the remaining balance is pardoned. This technique will certainly continue to grow in popularity now that the new bankruptcy law makes it harder to fully release debts in a Chapter 7 bankruptcy.
As with anything, there is absolutely no free lunch, and creditors are needed to report terminated 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 part of the debt. Because of this, many financial writers and debt counselors are strongly crucial of debt settlement, to the point where they really recommend against it just because you might end up owing taxes. But the tax consequences of settling your debts are tremendously 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 lot 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 difficult to understand why this is viewed as an issue in the first place!
Second, the great majority of people who settle their debts are not needed to pay taxes on the forgiven part of the balance. That is because of the "insolvency" rule, explained in IRS Publication 908, "Bankruptcy Tax Guide." Don't allow the title fool you. You don't need to have submitted 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 always comes down to home equity. If you have sufficient 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 thus 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 circumstance. Furthermore, be sure to read the section in IRS Publication 908 on "reduction of tax attributes," which requires folks using the insolvency rule to reduce their basis such things as rental property, loss carryovers, etc. Most of that probably will not apply to you, but again, get specific advice before winging it.
Thus, the message is, relax about paying taxes on canceled debt balances. That should be the very least of your concerns if you're upside down financially. Don't allow the misguided criticisms of financial writers (who haven't done their homework) discourage you from looking into one of the most well-known and versatile alternatives for attaining debt-freedom.
As with anything, there is absolutely no free lunch, and creditors are needed to report terminated 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 part of the debt. Because of this, many financial writers and debt counselors are strongly crucial of debt settlement, to the point where they really recommend against it just because you might end up owing taxes. But the tax consequences of settling your debts are tremendously 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 lot 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 difficult to understand why this is viewed as an issue in the first place!
Second, the great majority of people who settle their debts are not needed to pay taxes on the forgiven part of the balance. That is because of the "insolvency" rule, explained in IRS Publication 908, "Bankruptcy Tax Guide." Don't allow the title fool you. You don't need to have submitted 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 always comes down to home equity. If you have sufficient 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 thus 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 circumstance. Furthermore, be sure to read the section in IRS Publication 908 on "reduction of tax attributes," which requires folks using the insolvency rule to reduce their basis such things as rental property, loss carryovers, etc. Most of that probably will not apply to you, but again, get specific advice before winging it.
Thus, the message is, relax about paying taxes on canceled debt balances. That should be the very least of your concerns if you're upside down financially. Don't allow the misguided criticisms of financial writers (who haven't done their homework) discourage you from looking into one of the most well-known and versatile alternatives for attaining debt-freedom.
About the Author:
If you want more information on Income Tax, don't read just rehashed articles online to avoid getting ripped off. Go here: Income Tax