Debt Settlement and Your Taxes
Call the Attorney at (312) 544-0365 
Free Consultation
Debt settlement ads are very attractive to individuals struggling with debt. The promise is to reach an agreement you can afford to pay. The debtor agrees to pay a percentage of the debt (usually in a lump sum), and the creditor agrees to release the remaining obligation. Sounds simple, right?
Unfortunately, many times the debtor will receive a nasty surprise in the mail: an IRS Form 1099-C: “Cancellation of Debt.” You see, the U.S. Internal Revenue Service considers forgiven or canceled debt as part of your income. In fact, any creditor who agrees to accept at least $600 less than the original balance is required to file a 1099-C form with the IRS and to send debtors a canceled debt notice. If you have negotiated a debt settlement, you must report the forgiven or canceled debt as income on your federal income tax return. This usually causes a tax debt, since no money was withheld from this "income".
There is an exception to this situation. If you were insolvent at the time the debt was settled, the cancelled debt is not considered income. The IRS instructs the taxpayer to "determine your liabilities and the fair market value of your assets immediately before the cancellation of your debt to determine whether or not you are insolvent and the amount by which you are insolvent." Let's say your net assets after subtracting your liabilities amounts to $5,000. If you negotiate a debt settlement for $10,000, you must pay taxes on the first $5,000 of the cancelled debt. If your tax rate is 25%, you may Uncle Sam over a thousand dollars!
For debtors who have negotiated big savings through a debt settlement company, a large tax debt can be a slap in the face. Owing the federal government is much worse than owing a credit card company. Here are some interesting "facts" about owing the IRS:
* the IRS does not have to obtain a court judgment before garnishing your wages;
* recent tax debts are not dischargeable in bankruptcy;
* the IRS can intercept future tax refunds and even government benefits like social security to pay your income tax debt.
Congress has made sure that all debts discharged during bankruptcy are excluded from "Cancellation of Debt" income. If your debt is discharged in bankruptcy, the debt cannot be collected from you in the future, and you owe no taxes on it. If you can afford to repay a part of a debt, a Chapter 13 bankruptcy will allow you to pay what you can afford, over three to five years, and the remaining debt is usually discharged without a "Cancellation of Debt" tax obligation. If you cannot afford to repay any part of the debt, a Chapter 7 can discharge the debt within a few short months.
Debt settlement often makes a bad situation worse. Before you commit to a settlement process to eliminate your debts, speak with an experienced bankruptcy attorney. You deserve to know all of the consequences before agreeing to any financial program - including any potential tax liability. Your attorney will explain the pros and cons of debt settlement and bankruptcy, and can help you decide on the best course of action.
Legal disclaimer: Disclaimer: This answer does not constitute legal advice. I am admitted in the State of Illinois only and make no attempt to opine on matters of law that are not relevant to Illinois. This advice is based on general principles of law that may or may not relate to your specific situation. Facts and laws change and these possible changes will affect the advice provided here. Consult an attorney in your locale before you act on any of this advice. You should not rely on this advice alone and nothing in these communications creates an attorney client relationship.
ABOUT THE AUTHOR: Charles E. Glanzer
Charles Glanzer is one of the founding partners of Glanzer & Associates, P.C. Charlie has been licensed to practice law in Illinois since 1992, and has worked for some of Chicago's largest bankruptcy firms. Charlie focuses his practice on representing clients in Chapter 7 and Chapter 13 bankruptcy cases. Charlie represents his clients with a high level of sensitivity and professionalism, and has discharged millions of dollars of debt for his clients. Charlie's commitment to helping people in financial distress not only involves relieving his clients of their financial burden, but also counseling them about life after bankruptcy and rebuilding their credit.
Copyright Glanzer & Associates, PC
More information about Glanzer & Associates, PC
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
There is an exception to this situation. If you were insolvent at the time the debt was settled, the cancelled debt is not considered income. The IRS instructs the taxpayer to "determine your liabilities and the fair market value of your assets immediately before the cancellation of your debt to determine whether or not you are insolvent and the amount by which you are insolvent." Let's say your net assets after subtracting your liabilities amounts to $5,000. If you negotiate a debt settlement for $10,000, you must pay taxes on the first $5,000 of the cancelled debt. If your tax rate is 25%, you may Uncle Sam over a thousand dollars!
For debtors who have negotiated big savings through a debt settlement company, a large tax debt can be a slap in the face. Owing the federal government is much worse than owing a credit card company. Here are some interesting "facts" about owing the IRS:
* the IRS does not have to obtain a court judgment before garnishing your wages;
* recent tax debts are not dischargeable in bankruptcy;
* the IRS can intercept future tax refunds and even government benefits like social security to pay your income tax debt.
Congress has made sure that all debts discharged during bankruptcy are excluded from "Cancellation of Debt" income. If your debt is discharged in bankruptcy, the debt cannot be collected from you in the future, and you owe no taxes on it. If you can afford to repay a part of a debt, a Chapter 13 bankruptcy will allow you to pay what you can afford, over three to five years, and the remaining debt is usually discharged without a "Cancellation of Debt" tax obligation. If you cannot afford to repay any part of the debt, a Chapter 7 can discharge the debt within a few short months.
Debt settlement often makes a bad situation worse. Before you commit to a settlement process to eliminate your debts, speak with an experienced bankruptcy attorney. You deserve to know all of the consequences before agreeing to any financial program - including any potential tax liability. Your attorney will explain the pros and cons of debt settlement and bankruptcy, and can help you decide on the best course of action.
Legal disclaimer: Disclaimer: This answer does not constitute legal advice. I am admitted in the State of Illinois only and make no attempt to opine on matters of law that are not relevant to Illinois. This advice is based on general principles of law that may or may not relate to your specific situation. Facts and laws change and these possible changes will affect the advice provided here. Consult an attorney in your locale before you act on any of this advice. You should not rely on this advice alone and nothing in these communications creates an attorney client relationship.
ABOUT THE AUTHOR: Charles E. Glanzer
Charles Glanzer is one of the founding partners of Glanzer & Associates, P.C. Charlie has been licensed to practice law in Illinois since 1992, and has worked for some of Chicago's largest bankruptcy firms. Charlie focuses his practice on representing clients in Chapter 7 and Chapter 13 bankruptcy cases. Charlie represents his clients with a high level of sensitivity and professionalism, and has discharged millions of dollars of debt for his clients. Charlie's commitment to helping people in financial distress not only involves relieving his clients of their financial burden, but also counseling them about life after bankruptcy and rebuilding their credit.
Copyright Glanzer & Associates, PC
More information about Glanzer & Associates, PC
View all articles published by Glanzer & Associates, PC
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
