The Truth about Debt Settlement and Taxes
Critics of debt settlement are quick to point out that some debt settlement clients may owe taxes on canceled debt. It’s true – the IRS may consider your canceled debt taxable income. But let’s examine what this means before discounting a debt relief option that may help you avoid bankruptcy.
You may owe taxes on your canceled debts if your assets are worth more than your debts; for example, if you have enough home equity or another major asset such a second piece of property. This is not the case for most debt settlement clients.
When debt settlement clients do pay taxes on their canceled debts, many consider the additional tax a small price to pay compared to their previous debts, not to mention the interest rates attached to the debts.
However, many debt settlement clients do not have to pay taxes on canceled debt.
Taxpayers may not need to report the canceled debts as income if they were insolvent when the debt was canceled. Being insolvent simply means that the amount of your debts exceeds your assets. In other words, you owe more than you own. Most people with overwhelming debt are insolvent.
So paying taxes on canceled debt is a possibility, but many debt settlement clients are excused from paying taxes on canceled debt due to the IRS insolvency rules. Taxpayers can exclude canceled debt up to the amount by which they were insolvent. However, it is important to note that taxpayers must be able to prove they were insolvent and they must properly report this on their tax return, otherwise any canceled debt is considered taxable income. Consult with a knowledgeable tax preparer who is familiar with insolvency exceptions before claiming insolvency on your tax return.
If you do end up owing it will be because you successfully settled your credit card debts. In other words, if you save a lot of money on your debts, you may owe a little in taxes. You will still be saving money overall.
More Information about Debt Settlement and Taxes
- Taxpayers excluding canceled debts due to insolvency may need to submit IRS Form 982 with their tax returns.
- In addition to unpaid credit card balances, canceled debts remaining after property repossession and foreclosures are subject to similar laws.
- Taxpayers do not need to report debts that are canceled through bankruptcy.
- Taxpayers should consult with a tax professional for more information about reporting canceled debts.
To learn more about debt settlement, contact us today for your free debt analysis.
NOTE: Debt Shield is not a tax preparer or a law firm. This article is provided for informational purposes only and should not be interpereted as tax or financial advice. If you need tax advice, contact an authorized tax preparer.
