Debt settlement may be a way to deal with too much debt, but what does the IRS think of the money you saved? Considering that paying the bill would have constituted less of your income to live on, does saving the money count as taxable income? Not knowing the facts could cause you a heap of trouble.
Before you agree to a debt settlement amount, make sure you know the fine print of the tax laws.
The answer to the question is - maybe.
If you completely disregard the debt settlement agreement when you file your taxes, you could wind up with a hefty tax bill.
On the other hand, if you file the proper forms, you may not need to pay any extra taxes at all.
Clear as mud? Here's how it works: The first point to consider is the amount of the forgiven debt.
If the forgiven dollar amount is larger than $600, the IRS considers it taxable income.
If it is under $600, no tax needs to be paid on the forgiven debt.
The next point concerns a tax form called the 1099c.
When a creditor makes a debt settlement agreement, they must send a 1099c form to the debtor.
Here's where things start to get tricky.
The creditor has up to three years to send the form 1099c to you.
Whether or not you owe taxes on the amount, assuming it is over $600, depends on if you are considered insolvent - at the time the 1099c is sent, NOT at the time of the debt settlement.
Insolvent simply means your debts outweigh your assets.
It is most likely that you were insolvent when you settled your debts, or you wouldn't have made the arrangements in the first place.
Here's the other kicker- the tax is owed for the year the debt was settled.
This means if the creditor waits three years to send you the 1099c, the taxes are delinquent by three years and you will also owe penalties for being late on your taxes, as well as interest of 16% on the amount owed.
So, if you settled a debt in 2006 and were insolvent in 2006, but the creditor sends you a 1099c in 2009 and you are in financial happy land in 2009, you now have an overdue tax bill on the amount of debt that was forgiven (over $600) and you have to pay the taxes plus three years' worth of penalties and interest.
Here's the bottom line: if you settle a debt and are forgiven more than $600, call the creditor and demand your 1099c right away.
You will then pay the tax in the same year as you incurred the savings- and if you were insolvent at the time of settlement, you will still be insolvent at the time the 1099c is issued and won't owe the tax.
Before you agree to a debt settlement amount, make sure you know the fine print of the tax laws.
The answer to the question is - maybe.
If you completely disregard the debt settlement agreement when you file your taxes, you could wind up with a hefty tax bill.
On the other hand, if you file the proper forms, you may not need to pay any extra taxes at all.
Clear as mud? Here's how it works: The first point to consider is the amount of the forgiven debt.
If the forgiven dollar amount is larger than $600, the IRS considers it taxable income.
If it is under $600, no tax needs to be paid on the forgiven debt.
The next point concerns a tax form called the 1099c.
When a creditor makes a debt settlement agreement, they must send a 1099c form to the debtor.
Here's where things start to get tricky.
The creditor has up to three years to send the form 1099c to you.
Whether or not you owe taxes on the amount, assuming it is over $600, depends on if you are considered insolvent - at the time the 1099c is sent, NOT at the time of the debt settlement.
Insolvent simply means your debts outweigh your assets.
It is most likely that you were insolvent when you settled your debts, or you wouldn't have made the arrangements in the first place.
Here's the other kicker- the tax is owed for the year the debt was settled.
This means if the creditor waits three years to send you the 1099c, the taxes are delinquent by three years and you will also owe penalties for being late on your taxes, as well as interest of 16% on the amount owed.
So, if you settled a debt in 2006 and were insolvent in 2006, but the creditor sends you a 1099c in 2009 and you are in financial happy land in 2009, you now have an overdue tax bill on the amount of debt that was forgiven (over $600) and you have to pay the taxes plus three years' worth of penalties and interest.
Here's the bottom line: if you settle a debt and are forgiven more than $600, call the creditor and demand your 1099c right away.
You will then pay the tax in the same year as you incurred the savings- and if you were insolvent at the time of settlement, you will still be insolvent at the time the 1099c is issued and won't owe the tax.