1. July 1, 2024
2. Category: fastannuities

Facing debt can be stressful, and settlement is an appealing option. Here we explain how the IRS views forgiven debt and the potential tax implications it can have. Navigate the world of debt settlement with clarity – financial well-being starts with understanding the full picture.

Debt settlement is a process that allows borrowers to settle their debts for less than they owe. However, in most cases, any debt that is forgiven will be subject to income taxes. Here is what you need to know.

Taxable Income From Canceled Debt

You can attempt to settle your debts with creditors on your own or with the services of a debt settlement or debt relief company that will charge you a fee for its services. (While there are legitimate debt settlement companies, the Consumer Financial Protection Bureau warns that they “can be risky” for several reasons.)

With certain exceptions, any debt you manage to have discharged or canceled by a creditor is considered taxable income under federal law. That means you must report it when you file your tax return for the year and pay taxes on it—even though you didn’t receive any actual money.

As an example, suppose you have $20,000 in credit card debt, and, after negotiations, the lender agrees to accept $12,000 as payment in full. In that scenario, you would have $8,000 in taxable income to report on your tax return.

The process works a little differently with secured debt, such as an auto loan for which the car serves as collateral. (Credit card debt is typically unsecured debt.) If, for example, you fall behind on your car payments, the lender can repossess the vehicle and sell it. Whatever amount the lender receives from selling the car will reduce the debt you owe but generally not eliminate it. You can then attempt to settle the remaining debt for a lower amount. If the lender agrees, the amount you save becomes taxable income.

Exceptions to Taxable Canceled Debt

The Internal Revenue Service (IRS) does list some exceptions to these rules. For example, the following types of debt are not considered canceled debts for tax purposes:

• Debts canceled as “gifts, bequests, devises, or inheritances”
• Certain qualified student loans that qualify for student loan forgiveness programs based on your profession
• Eligible student loan discharges after Dec. 31, 2020, and before Jan. 1, 2026
• Student loan debt forgiven under Public Service Loan Forgiveness (PSLF)
• Amounts of canceled debt that would be deductible if you, as a cash basis taxpayer, had paid it
• A qualified purchase price reduction given by the seller of property to the buyer

In addition, some debts that are considered canceled are not subject to income tax. Those include the following:

• Debt canceled in a Title 11 bankruptcy case (Title 11 includes Chapter 7, Chapter 11, and Chapter 13 bankruptcy, among others)3
• Debt canceled to the extent insolvent
• Cancellation of qualified farm indebtedness
• Qualified real property business indebtedness
• Qualified principal residence indebtedness that is discharged before Jan. 1, 2026

Reporting Canceled Debt on Form 1099-C

When a creditor cancels all or part of a debt you owe in an amount that’s more than $600, the company you owed money to will typically send you a Form 1099-C: Cancellation of Debt. It provides the information you’ll need when you file your tax return for the year the debt was forgiven, including the amount of debt canceled and the date the cancellation occurred.

Note that you are still legally required to report the canceled debt amount even if the creditor does not send you this form. If you receive a 1099-C reflecting incorrect information, the IRS recommends contacting the creditor to request an updated form with the correct information.

Tax Implications of Settling Different Types of Debt

As mentioned, you’ll owe federal income tax on any debt that is canceled or discharged, regardless of the type of debt, unless it falls into certain categories eligible for exclusion (described above).

That debt will be taxed at the same rate as your ordinary income. How much you’ll have to pay will depend on your marginal tax bracket for that year. Currently, ordinary income is taxed at anywhere from 10% to 37% on the federal level.

In some cases, your state’s tax rules may differ from the federal ones.

Need access to cash? FAST Annuities puts you in control. Schedule a consultation with a financial advisor today at 855-898-3278 or visit our Instagram for ideas and tips: @fastannuities.

Reference: [https://www.investopedia.com/tax-consequences-debt-settlement-8424582]