Beware of the Debt Settlement Tax – What to Look For, What to Do
If you’re still in debt, you’re probably thinking about talking to your creditors about settling your debts for less than you owe. Beware, though. What you probably don’t know about debt settlement is that it can have a great impact on your taxes.
If you’re settling your debt for less than you ow, the tax laws consider this the same as “earning” money. One example would be if you took out a loan for $10,000 and were unable to pay it back. If you settled for $6,000, you have essentially pocketed $4,000. This really gets the attention of the IRS.
At some point in the past, there probably was a loophole in the U.S. tax laws that allowed for this kind of thing to happen. Sadly, the IRS quickly gets smart about these things. Like many other loopholes in the tax law, this one has been closed.
As I mentioned in the example above, settling credit card debt or any other debt for less than you owe your creditor will probably result in you being held liable for the “profit” you realize after paying off your debt. Keep this in mind when you file your taxes after settling your debts.
Even though this may sound like a bad thing, you still come out ahead after taxes. In our example above, the $4000 you realized as a gain might be taxed at 30%, depending on your tax bracket. However, even when you add the $1200 tax, you’ve still only paid $7200 to clear a $10,000 debt. That’s still a bargain in my book.
Because the debt settlement tax comes as a surprise to many people, they don’t do anything about it until the IRS comes to audit them. Don’t let this hidden tax take you by surprise.
If you need any more details on how to deal with this tax, please check with your CPA or another tax expert.
