Don't Celebrate Your Cancelled Debt, You Must Pay Taxes on It!

If you have ever owed money on a credit card or loan and you were successful in getting the debt cancelled, you felt like the weight of the world was off your shoulders. The collection calls stopped and you felt out in the clear air where you could breathe again, and you are, except for the IRS.

Let's say that you were $10,000 in debt to a credit card company and that you successfully negotiated that debt down to $5000. The credit card company is willing to cancel $5000 of your debt and act as if you never owed it, but not the IRS. The Internal Revenue Service will treat the cancelled $5000 as income and you will owe taxes on an additional $5000 on your income tax return for that year.

When your creditor who forgave the debt goes through the process required to "erase" that debt, they will issue you a form 1099 to sign. After you sign it, they will forward it to the IRS. The Internal Revenue Service will treat that $5000 as "other income," related to line number 21 on your form 1040 income tax return.

The only exemption to this process is in the event the debt forgiven was in relation to your primary residence; that the debt reduced was a mortgage or Home Equity Line of Credit (HELOC). Otherwise, you are on the hook to the federal government for the applicable taxes on $5000 additional income. That's not good news for someone who thought he was out of the woods regarding this debt.

That is why; if you are in financial trouble, don't just jump at the chances offered you to reduce your debt. It is good that you were able to get a successful negotiation with your creditor, but you must carefully weigh all the implications surrounding any deal related to your debt. There are contingencies, loopholes, and complications to any financial negotiation. You must go into these things fully and absolutely prepared.

If you have decided to represent yourself in such negotiations, it is going to take a whole lot of research to be certain you don't miss anything (like Internal Revenue Service regulations) that could potentially cause you even more trouble.

It is therefore recommended, that in matters of serious financial restructuring, you consult a professional financial advisor and/or an attorney. In this way, you know you will receive the advice of experienced professionals who can manage the results of your financial management to best reflect your needs and interests, hopefully without IRS surprises.

If you are successful in negotiating with a credit card company to cancel a part of your debt, it is doubt a victory for you. However the issue does not end there. IRS will come forward to demand taxes on such debt! What precautions should you take while negotiating with a credit card company to creditor, requesting cancellation of your debt? Chintamani Abhyankar provides useful tips.

Chintamani Abhyankar, is a well known expert in the field of finance and taxation for last 25 years. He has written many books explaining inside secrets of the magic world of personal finance. His famous eBook Stop donating your money to IRS which is now running in its second edition, provides intricate knowledge and valuable tips on personal finance and income tax.