Credit Card Debt Forgiveness Rules
The laws surrounding credit card debt forgiveness are indeed a tricky slope to navigate. Anyone who has ever run into financial problems because of credit cards has either thought about settling the debt or contacted a creditor and actually had the debt settled. Settling a debt can take the strain off the budget, but there may or may not be tax consequences associated with the process. There are several circumstances that will help determine if you have a tax obligation to fulfill after debt forgiveness.
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Debt Settlement
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To settle a debt, you contact a creditor and make arrangements to pay less than the outstanding balance. The amount you settle for depends on your negotiating skills and what the creditor is willing to accept. There have been some individuals who have been able to arrange settlements for approximately 50 percent of the balance.
1099-C Form
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Once you settle a debt, the creditor will send you a 1099-C cancellation of debt form, which instructs you to report the settled debt as taxable income when you file your taxes. If you have a credit card balance of $7,500 and your creditor accepts a settlement offer of $5,000, you must report the difference of $2,500 as income on your tax forms.
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Exceptions
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In certain situations, you may not have to report your settled debt as taxable income. If you are were granted relief through bankruptcy, you are excluded from this tax rule. Another exception centers on the status of your assets and liabilities. According to the IRS, if your liabilities exceed your assets, then your credit card debt may not have to be reported as taxable income. Before you try to estimate or calculate your insolvency, take your 1099-C forms to a tax professional for advice and guidance. They may suggest you file the IRS Form 982 along with the 1099-C if you qualify. These laws are not as simple and straightforward as one would think.
Debt Proposal
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The banking industry and consumer advocate groups tried to put a pilot program in place that would give credit card companies the ability to forgive credit card debt for certain consumers. People who were enrolled in debt management programs would have been allowed to wipe out approximately 40 percent of their debt. Those in the program would be given five years to pay back the remaining debt. Under this proposal, credit card companies would not have to report bad debt for five years, helping to reduce their reported losses for a given time period.
Bad Debt
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Writing off credit card debt helps companies clear up their books, which increases their chance of survival. Credit card companies are trying to collect whatever they can on debts gone bad, and debt forgiveness is one way to do it. Banks are expected to write off more than $390 billion dollars over the next five years, according the Nilson Report, a credit card industry newsletter.
Credit Score
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Even though you stand to gain a substantial amount of relief if your credit card debt is forgiven, there is a downside. Your credit score could be reduced, depending on your situation, anywhere from 70 to 130 points. This jeopardizes your ability to get credit in the future. Any loans or new credit products for which you are approved will be at a higher rate of interest, along with a number of fees.
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References
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