What are the Laws Concerning Debt Reduction?
If you have an excessive amount of debt, you may want to consider a debt reduction or debt settlement program. Reducing your debt can take the strain off the budget, which helps you manage your financial matters more effectively and efficiently. There are certain laws established by the IRS which you need to abide by. Some of the laws will impact your taxes.
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Terms
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Once you decide to settle your debt, contact your creditors and make an offer. Creditors will accept settlement offers if your account is at least 90 days past due. You can probably negotiate a settlement anywhere from 20 to 75 percent of your outstanding balance, which is the range that creditors are willing to accept. Once your settlement is received, your account will be paid in full.
Form 1099-C
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When you negotiate a settlement, there could be some tax implications. You may be required to report the settled credit card debt as taxable income when you file your taxes. If your balance is $8,000 and you negotiate a debt reduction settlement of $5,000, the remaining $3,000, which is forgiven debt, may have to be reported as taxable income. Your creditor will send you a 1099-C, which is a debt cancellation form to be filed with you taxes. Always contact your tax professional if you receive this form.
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Considerations
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There are a couple of scenarios that would exclude you from reporting your forgiven debt as taxable income. When you settle your debt, if you are insolvent at the time, which means your liabilities exceed your assets, you don't have to report the credit debt as taxable income. You may be required to prove that you are actually insolvent. Good record keeping will help you make the determination more efficiently and effectively. If you feel that you are insolvent, you will need to fill out IRS form 982 in detail. After completing this form, it will need to be attached to your income tax return when you file.
If you decide to file a petition for bankruptcy protection, your forgiven debt does not need to be reported as taxable income. A bankruptcy will completely wipe out the need to report this as income.
Mortgage Debt
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Any mortgage debt, which is forgiven and incurred as a result of acquiring, improving or refinancing your home, does not need to be included as taxable income. This became effective 2007 with the Mortgage Debt Forgiveness Act and is slated to run until the year 2012.
Amended Tax Return
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When you report canceled credit debt as taxable income and then you decide to repay some or all of it, the law states that you can file an amended tax return, form 1040X, and receive a refund as long as the statute of limitations has not passed. The statute ends three years after the original tax filing date or two years after you actually paid the taxes. The later date of the two should always be used.a
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