Debt Settlement & Taxes
When trying to pay off debt, many people turn to companies that can negotiate with their creditors on their behalf. Often, these companies can work with an individual’s creditors to forgive or cancel some or all of a debt. While this is an excellent step towards paying off debt, many consumers who use these services are concerned with the tax implications of forgiven debt.
In fact, one of the most common disadvantages of using a debt settlement service to pay off debt is that there can be potential tax liabilities. In general, the IRS views forgiven as a source of income that must be reported as taxable income. Specifically, the IRS mandates that all taxpayers report any cancelled debts with a balance of $600 or more on Form 1099. Reporting forgiven debt as income can increase the overall amount owed in taxes to the IRS.
Fortunately, there are several important points that any consumer seeking to pay off debt should keep in mind. The IRS does not require taxpayers who are considered insolvent to pay tax on debts which have been canceled or forgiven. A lot of taxpayers qualify as insolvent at the time of settlement, which means they are not required to pay taxes on the forgiven balance of their debts.
In fact, a taxpayer does not have to file for bankruptcy to be considered insolvent.Insolvency, according to the IRS, is the financial state in which ones liabilities or the amount of debt he or she owes exceeds his or her assets. Since so many consumers who consider debt settlement are so overextended, many of them qualify as insolvent. Consumers who believe that they qualify as insolvent can fill out an IRS Form 982 with their tax returns. By filling out this form, consumers may not have to pay taxes on some or all of the forgiven loan balance. Of course, consumers should always talk to a tax professional about their individual tax situation.