Debt Settlement: What Happens When You Have Your Debts Forgiven or Settled?

The economy is in such bad shape that a lot of people are not able to manage their financial affairs. Many consumers are overwhelmed with a mountain of credit card debt. When this happens people look for some type of outlet that will help their budgets become more affordable. One avenue they pursue is debt settlement or debt forgiveness.

When you settle your debts you immediately receive relief from a heavy debt load. Is it good to settle your debts or have a creditor forgive them? Well it all depends. Whenever you settle your debts there is a sequence of events that take place. First of all you can end up settling your debts for 50 percent of the outstanding balance or whatever you can negotiate with your creditors. There are a lot of creditors willing to accept less than 50 percent of what you owe. You can also have some fees waived by your creditors such as late charges or over the limit fees. Some creditors will reduce your interest rate. So there are a lot of positive things that take place when you settle your debts.

Settling you debts can lead to some negative situations as well. This information will lower your credit score and stay on your credit report for seven years. The account information will be reported on your file as, 'paid settlement, or settled debt. Any other creditor reviewing your credit file will know that you had to settle your debts because of financial difficulties. They will be very reluctant to approve you for any type of credit product. If they decide to approve you the interest rate will be substantially higher than you would pay if you had good credit. Some credit card companies will charge you a number of fees such as activation fees, account set up fees, annual fee, or a monthly maintenance fee. These are credit cards for people with bad credit.

It doesn't stop there. When you settle your debts there are some tax implications. For example if you have a credit card balance of $8,500 and you call a creditor and settle for $4,500 you may have to report the remaining balance of $4,000 as taxable income when you file your taxes. Your creditor will probably send you a 1099-C, which is a debt cancellation form. If you should receive one of these take it immediately to your tax professional or your tax advisor and they will give you some direction on how to proceed.

There are two scenarios in which you may not have to report your settled credit card debt as taxable income. If you file a petition for bankruptcy or if the IRS determined that you were insolvent when your debts were settled or forgiven. To be insolvent means your liabilities exceeded your assets. Don't try to make this determination yourself; speak with a tax attorney or tax professional. If you meet one of these two requirements your tax person may have to file a form 982 in addition to the 1099-C from. The 982 form provides information that shows why you should not have to pay taxes on the forgiven debt.

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http://www.bankrate.com/brm/itax/news/20030303a1.asp Forgiven Debt could Increase Your Tax Bill