Will debt settlement affect my taxes?

Question

Will debt settlement affect my taxes?

Answer

Understanding a debt settlement is an important step to understanding how it can affect your financial situations. Even after the debt is paid back, it can still affect you. If you owe $1,000 to a creditor, and the creditor agrees to settle the debt for $300, you were “paid” $700. In other words, the $700 paid to you is income according to the IRS, and it is required that you report that income to the IRS at the time of filing your income taxes.

Debt and Income

When working with debt settlement, it is important to consider the ramifications of settling a debt. While the lender may be unable to come after you for a debt settled legally, it is still necessary to report this to the IRS as income or you could face IRS taxes and more debt as a result. There are 2 primary reasons for this:

  • If you do not report the debt settlement to the IRS, the IRS could audit you for it. This is because the creditor is required by law to report any settlements valued at more than $600 to a person.
  • In some cases, adding this settlement amount to your income taxes may increase your tax bracket, meaning you may have to pay taxes on the funds.

Finding Legal Assistance

When considering debt settlement, take into account the effect on your taxes. Work with a debt settlement attorney to determine if the consequences of paying off your debt through a settlement will have a negative impact to your tax filing. In most cases, you will still benefit from a debt settlement. 

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