You Could Pay Taxes on Settled Debts

Debt settlement offers relief on one end, but it may come back to bite you on the other end. The IRS (Internal Revenue Service), the agency responsible for tax collection and tax law enforcement, requires businesses to report any cancelled debts over $600. Not only does the business report the debt cancellation to the IRS, it’s also required to send you notification of the reported cancellation. The business gets a tax break that could be funded by you.

You’re required to report cancelled debts on you income tax return. Reporting the debt increases your taxable income and could potentially put you in another tax bracket, especially if you were teetering on the edge of brackets to begin with. That means you could end up owing Uncle Sam if you didn’t have enough money withheld to cover the increased tax responsibility. If you’re getting a refund, your check would end up being less.

Debt cancellation counts whether the business forgave the entire debt or just part of the debt (like with debt settlement). It doesn’t matter whether you used a debt settlement firm or whether you negotiated the debt yourself, a cancellation is a cancellation.

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If the debt was cancelled due to a bankruptcy discharge or because you were insolvent, you won’t have to pay taxes on it. Insolvency occurs when your liabilities (debt) are more than your assets.

If you receive a 1099-C Cancellation of Debt form from one of your ex-creditors or lenders consult with your accountant or tax preparer to find out whether you’ll have to include the cancelled debt on your tax return and how the debt cancellation will affect your tax liability.

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