Tax Implications of Debt Settlement

(The author of this piece is not a CPA, lawyer, or tax consultant. This is meant for educational purposes only and for tax advice regarding your situation, please contact a licensed professional.)

One of the common disadvantages of using debt settlement for debt relief is that there can be potential tax liabilities associated with your savings. The IRS mandates that taxpayers report cancelled debts with balances of $600 or more on Form 1099 as income. While this may potentially cause the overall cost of your debt settlement program to increase, there are several important points that any consumer seeking debt relief should keep in mind.

2) Many taxpayers are technically insolvent at the time of settlement, which means they aren’t required to pay taxes on the forgiven balance anyway. One need not file bankruptcy to be considered “insolvent.” Insolvency, as defined by the IRS, is a financial state where one’s liabilities (debt owed) exceed their assets (equity in property). Many consumers who are considering debt settlement are so overextended that being insolvent, or having a negative net worth, is likely. By filling out an IRS Form 982 with their tax returns, consumers are relieved of their tax obligations on the forgiven balance by the amount which they are insolvent. For more information, one should always talk to a tax professional about their individual situation, however.

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