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Will I Face a Tax Liability If I Choose Debt Settlement?

A growing number of people have experienced financial hardship recently, and an equal number of these individuals, families and small businesses are considering options which may help to eliminate their debt, including debt settlement. Oftentimes, people are concerned that they will face a tax liability as a result of their canceled debt, and it’s very likely you’re asking yourself this same question.

Yes, there is a possibility that you may be required to pay taxes on the amount of money you save when a creditor agrees to settle your account for less than the full balance. You see, if you choose this option, creditors are required to send you IRS Form 1099C for the tax season in which your debt was settled. For instance, if you owe your creditor $ 10,000.00, and they agree to settle your account for $ 3,500.00, you will receive IRS Form 1099C, reflecting earnings of $ 6,500.00 (the amount of debt forgiven).

Whether or not you will face a tax liability, however, depends on your current overall financial situation. You see, many people who choose debt settlement are not liable for taxes on their forgiven debt. This is due to the fact that the IRS has in place an “insolvency” rule, which states that no income taxes will be due if you can prove insolvency during the tax year that your debt was settled. This basically means that if your debts exceed your assets during the tax year, you are very likely considered insolvent, having a negative net worth, and will probably not face a tax liability.

In order to determine whether or not you qualify for this insolvency rule, simply deduct the amount of your liabilities from the amount of your assets. If you find that you are indeed insolvent, you’ll want to include IRS Form 982 with your 1040 when filing your taxes for that year; this is the form that the IRS uses to determine insolvency.

Most people who consider debt settlement are doing so because they simply can no longer afford to pay their bills, and many of these same individuals are indeed insolvent. If, however, you find that you are not insolvent, I wouldn’t recommend that you let a possible tax liability determine that debt settlement is out of the question. You see, it’s important to remember that the amount of money you may pay in taxes will be significantly less than the amount of money you would have paid to your creditor(s) had you continued to attempt to meet your minimum monthly payments.

What’s most important is your peace of mind and financial well-being. If you’re considering debt settlement, it’s a good idea to contact several companies, as well as a tax adviser to determine if this is the right choice for you. I wish you the best.

Marie Megge is a consultant in the credit services industry. Over the past several years she has assisted hundreds of individuals, families and small businesses in resolving their debt-related matters. For more information regarding credit and debt settlement visit

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