Tax implications of debt settlement

The economic recession has left millions of American families in severe debt. A lot of people are no more in a position to completely repay their debt. Therefore, they are trying to settle their debt. This can be a reasonable move because a large part of your debt is forgiven in settlement. There will be no more sleepless nights due to huge payments and nasty creditor calls. A blissful and debt free life indeed beckons you via debt settlement. However, there is a problem. Many people overlook the fact that debt settlement can
have tax consequences. Yes, the IRS might chase you to collect taxes on the forgiven amount. So you won’t owe money to any financial institution but you will be indebted to the IRS. Doesn’t sound nice, does it? No matter how much you dislike it, you got to pay taxes on the cancelled debt.

When consumers rack up huge credit card debt, many creditors sell the debt to collection agencies. Next, the collection agencies try to recover the money from the consumers. At this point, many consumers try to negotiate a settlement with the collection agency. Suppose you have a debt of $10,000. After negotiating with the agency, this debt trims down to $5000. In this case, the IRS would consider the money you saved ($5000) as income and would tax you for it.

There are reasons for you to worry. The government can very well sue you if you do not pay your taxes. Just imagine you have a home loan of $150,000 and your lender has forgiven 50% of the debt. What happens if you need to pay taxes on $75000? You would face serious trouble. But you need not worry. There is a solution to this problem. The government has a way out for people trapped in such a situation. You do not need to pay taxes on forgiven debt if all the following conditions are satisfied:

1. The forgiven debt should be under $2 million.


2. The debt reduction should be related to your primary residence.

Tax consequences due to cancelled debt can be troublesome. Therefore, it is always wise to consult a tax attorney about the implications of forgiven debt. Otherwise, debt settlement may not be of much use to you.

Debt settlement can certainly pull you out of financial difficulties. But tax consequences on forgiven debt can nullify the positive aspects of this program. So think carefully before making a decision.