Taxes on Credit Cards & Debt Forgiveness
After working tirelessly to negotiate a lower balance on your credit card debt, the last thing you want to face is a tax bill. Depending on how much your credit card company forgave and your specific tax situation, however, that is exactly what could happen. Keep your potential tax liability in mind whenever you agree to pay a settlement to a credit card company or any other commercial creditor.
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Forgiven Debt
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Credit card companies want to collect debt–not forgive it. Each credit card provider’s policies regarding forgiving debt differ, but many would rather offer a settlement to the debtor than sell the debt to a collection agency or unsuccessfully continue trying to collect the full amount.
When a credit card company offers you a settlement and you accept, the company not only receives partial payment of the delinquent balance, it also has the right to claim the unpaid portion of your credit card bill as a tax deduction.
Tax Liability
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Your credit card company does not pay taxes on the forgiven portion of your credit card balance. The Internal Revenue Service loses money by allowing the company to claim a bad debt deduction. It recovers the lost funds by treating the forgiven portion of your credit card balance as a financial “gift.” You must pay taxes on the forgiven balance as if it were money you earned over the course of the year.
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Considerations
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It is your responsibility to keep up with the exact amount the credit card company forgaveto complete your tax return accurately. Although the credit card company may send you a Form 1099-C noting the exact amount it claimed as a deduction, the IRS does not require the company to do so if the unpaid balance, excluding interest charges and other fees, does not exceed $600.
Warning
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Creditors do not have the option to refuse a deduction on bad debt. Thus, you may receive a 1099-C even if your credit card company did not offer you a settlement and write off the balance.
If you neglect to pay your credit card debt, the credit card company must eventually write off the debt and claim the entire account balance as a tax loss. Unless you have a written statement from your creditor noting otherwise, the credit card company can still sell your debt to a collection agency, which will attempt to recover the debt regardless of whether or not you already paid taxes on the unpaid balance.
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