As an increasing number of credit card companies are agreeing to settle cardholder debts, it’s important that individuals recognize that there may be minor tax consequences associated with the settlement. A debt settlement is when the creditor allows the account holder to pay less than what is owed and consider the account paid in full.
A partially or fully forgiven debt through a settlement is sometimes considered as taxable income by the IRS and must be reported on your tax return if you saved more than $600 during the settlement. So if you owed $5000 on your credit card, and settled for $2,500 you would have to report $1,900 as income ($2,500 minus $600). The credit card company that settles the debt will send you and the IRS a Form 1099-C reporting the forgiven amount.
There are exceptions to having to count the forgiven debt as income, for individuals who are insolvent at the time of the settlement. Insolvent means you owed more than the fair market value of your assets.
A settled debt typically is marked as such on your credit report as well, which is better than a bankruptcy, but not as good as “paid in full” or “paid as agreed”.
If you do end up having to pay taxes on the amount of debt forgiven, chances are you will still come out ahead than if you continued to struggle and repay that debt with 27% interest and credit card late fees.
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