Should I include my debt settlement in my tax return?

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Debt settlement involves reaching an agreement with a creditor to accept less than the balance on an account. When a credit cardholder starts falling behind on payments, credit card companies and other creditors often accept less than the owed amount. The reason behind a debt settlement is that creditors strive to get what they can once they realize that the debtor is unable to pay as agreed.

Although this might sound like an ideal solution to your financial problems, it’s not that simple. The fact that your creditor might agree to settle a credit card debt, or any other debt, is not the end of the problem for you. There are some settlement and income-tax-related questions you should consider before filing your income tax return.

1. What is the difference between debt settlement and debt forgiveness?

 Forgiven debt is the difference between the settled amount and the owed amount. For example, if you owe $2,500 and you settle the debt for $1,800, the forgiven amount (forgiven debt) is $700.

2. Should I report my debt settlement to the IRS?

The IRS considers a forgiven amount of $600 or more as earned income. You should inform your tax preparer if you had $600 or more in debt forgiveness during the tax year. You do not need to report a forgiven amount of less than $600.

3. How to tell if my debt settlement is taxable?

You will receive a 1099-C form from your creditor. The form contains the forgiven amount. Creditors have until January 31 of the following year in which you settled the debt to mail out the form. The IRS must receive its copy of form 1099-C by February of the following year in which the debt was forgiven.

4. What should I do if I receive a 1099-C form?

Do not throw it away. Keep it in a safe place. Present the form to your tax preparer. Make sure that he includes the amount that appears in box 2 of the form on your income tax return.

5. Is a debt settlement always taxable?

Under certain circumstances, your settlement might not be taxable. For example, debts discharged through bankruptcy are not taxable, and you do not need to report them to the IRS. If a creditor forgives the balance on your account and treats it as a gift, you do not need to  include it in your income tax return. If the amount owed was the result of a business loss, tax liability might not apply to you. Another scenario where your settlement might not be subject to tax liability is if you had more debts than assets when you reached the settlement.  

Be sure to consult a licensed tax preparer if you had any debt settlements during the tax year. Ask if you qualify for any tax exclusions.

Debt forgiveness is the result of a debt settlement. The forgiven amount is the portion that the debtor writes off as uncollectible. If you reach a debt settlement with a creditor, be on the look out for form 1099-C. Be sure to present it to your tax preparer and find out if you qualify for any tax exclusions. 



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