Debt settlement has turned into a well-known approach to solving problem debts without having to declare bankruptcy. With this particular strategy, creditors consent to accept a portion of what you owe (usually around 50% or less) to pay the account, and the remaining balance is forgiven. This technique will certainly keep growing in recognition now that the new bankruptcy law makes it harder to completely release debts in a Chapter 7 bankruptcy.
As with anything, there is no free lunch, and creditors are needed to report canceled debts to the IRS on Form 1099 (when the canceled balance is $600 or greater). Consequently, 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 highly crucial of debt settlement, to the point where they really suggest against it just because you might end up owing taxes. However the tax consequences of settling your debts are tremendously over-emphasized, and this is a really just a small issue at best.
First, even if you wind up owing taxes on the canceled balances, that is 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 start with. There is still a net savings. Therefore it is difficult to understand why this is viewed as an issue in the first place!
Second, almost all of people who settle their debts are not required 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 filed a formal declaration of bankruptcy to take advantage of the insolvency rule.
Basically, "insolvent" means that you have a negative value -- 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 many 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, most people in critical 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, make sure to get professional tax advice specific to your circumstance. Also, make sure to read the section in IRS Publication 908 on "reduction of tax attributes," which requires people using the insolvency rule to lessen their basis in such things as rental property, loss carryovers, etc. The majority of that probably won't apply to you, but again, get specific advice just before winging it.
So, the message is, relax about paying taxes on canceled debt balances. That should be the least of your worries if you're upside down financially. Don't allow the illinformed criticisms of financial writers (who haven't done their homework) dissuade you from looking into one of the most well-known and versatile alternatives for achieving debt-freedom.
As with anything, there is no free lunch, and creditors are needed to report canceled debts to the IRS on Form 1099 (when the canceled balance is $600 or greater). Consequently, 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 highly crucial of debt settlement, to the point where they really suggest against it just because you might end up owing taxes. However the tax consequences of settling your debts are tremendously over-emphasized, and this is a really just a small issue at best.
First, even if you wind up owing taxes on the canceled balances, that is 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 start with. There is still a net savings. Therefore it is difficult to understand why this is viewed as an issue in the first place!
Second, almost all of people who settle their debts are not required 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 filed a formal declaration of bankruptcy to take advantage of the insolvency rule.
Basically, "insolvent" means that you have a negative value -- 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 many 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, most people in critical 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, make sure to get professional tax advice specific to your circumstance. Also, make sure to read the section in IRS Publication 908 on "reduction of tax attributes," which requires people using the insolvency rule to lessen their basis in such things as rental property, loss carryovers, etc. The majority of that probably won't apply to you, but again, get specific advice just before winging it.
So, the message is, relax about paying taxes on canceled debt balances. That should be the least of your worries if you're upside down financially. Don't allow the illinformed criticisms of financial writers (who haven't done their homework) dissuade you from looking into one of the most well-known and versatile alternatives for achieving debt-freedom.
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