About thirty-three percent of Americans have delinquent debt, with medical and student loan debt making up the lion’s share. Credit card debt comes in a close third. If paying your credit card debt becomes unmanageable, you should consider debt relief options.
Though you should repay your debt in full, debt relief can help you pay a portion of it. However, because you are not fulfilling your debt obligations in their entirety, there will be tax implications. You should understand the connection between credit card debt relief and your taxes.
How Credit Card Debt Relief Works
Debt settlement is the most prevalent form of credit card debt relief. When a borrower cannot pay back their credit card debt, they will contact a debt settlement company. The company will negotiate a debt settlement agreement with credit card companies on behalf of the borrower. The amount to pay when you get help with credit card debt is typically less than the amount the borrower owes.
The settlement option you’ll find at www.freedomdebtrelief.com, or any other debt settlement company is usually offered in the form of a payment plan or a one-time payment. The creditor will accept either, as it is the only way they can recover a portion of the debt. However, when you start settling the debt, the creditor is required to report it to the IRS.
Tax Consequences of Settling Credit Card Debt
Credit card debt relief essentially means that the creditor forgives a fraction of the debt. When they do, the IRS considers the forgiven amount taxable income. Because the creditor has to report the forgiven debt to the IRS, it will affect your state and federal taxes.
When the forgiven debt is more than $600, the credit card company will send you a 1099-C form when the tax year ends. You must report the forgiven debt amount on the form when you file your tax returns.
Just because the creditor does not send you the form, it does not mean they did not report it to the IRS. Therefore, you should fill out the form yourself and report it.
If you do not report the forgiven debt, but the credit company does, you will receive a tax bill or get audited by the IRS. The tax penalties can be substantial.
Exceptions To The Tax Implications
Though you may have credit card debt relief, there are situations where tax consequences may not apply, such as:
Insolvency
When you are insolvent, it means your total debt is more than your total assets. If you are declared legally insolvent, you will be exempt from paying taxes on the forgiven debt. However, it will be limited by the amount you are insolvent.
For example, if you have assets worth $50,000 but have debts worth $80,000, you are $30,000 insolvent. If the forgiven debt amounts to $35,000, you must pay taxes on the $5,000 difference.
Bankruptcy
Your forgiven credit card debt cannot be taxed by the IRS if it is forgiven due to bankruptcy. The exception works for any kind of bankruptcy. Moreover, there is no limit on the amount of nontaxable forgiven debt in case of bankruptcy.
Declaring Exemption
For you to enjoy tax exemption on your forgiven credit card debt, you must declare it to the IRS. The IRS requires you to fill out form 982 which determines how much of your settled credit card debt is exempt from taxation.
The amount of forgiven debt in form 982 must equal the amount you declare in the 1099-C form.
Otherwise, you will arouse suspicion, and the IRS will audit you.
Credit Card Debt Relief Affects Your Taxes
It would be best to understand how credit card debt relief and your taxes are linked. This article provides the basics of the connection, but there is much more to learn.