Beware Of The IRS If Your Creditor Writes Off Or Settles A Debt

Often times, when you deal with a debt settlement company or file for bankruptcy, your debt that was owed is written off or settled by your creditor for a lesser amount. The debtor should be aware of the possible results of this process. Because there is a loss to the creditor, he or she may report it as lost income, therefore, it is taxable. The one whose debt is forgiven may have to pay taxes on that lost income.

If a company settles a debt for less than the full amount, the company is likely to report a tax loss to the Internal Revenue Service. In the year that the debt was settled, the debtor must include the amount as income for that year. The debtor is required to do this by law because forgiven debt is considered as income by the Internal Revenue Service. He or she may disregard the debt because it has simply been wiped away by the creditor.

If the debtor does not report this written off or settled debt on his or her tax returns, he or she may receive an unexpected tax bill or an audit notice from the IRS.

This is a major problem for many reasons. There are many forms of debt that people owe, but do not realize the consequences that may occur when settling with the creditor or having the creditor write the debt off as a bad debt. Money that is owed by a debtor on foreclosure property is subject to taxation under this law. Also, delinquent credit card bills may be subject to these taxes. Even property that has been repossessed is subject to it.

Another problem is that the creditors will often notify the IRS about the debtor's forgiven debt and never notify the debtor. The debtor is then unaware that they need to include it as income. The IRS is notified by the creditor issued by what is known as a Form 1099-C. Both the IRS and the debtor should receive this form in this situation, however sometimes the debtor is left out entirely.

There are three situations that would allow a debtor to exclude their written-off or settled debt from taxation by the Internal Revenue Service. The first is the actual write-off of the debt itself was considered as a gift to the debtor. The second is the debt was discharged through the process of bankruptcy and the third is because prior to the debt settlement, the debtor was considered to be insolvent.

It's imperative that you determine what taxes you owe and to whom, as well as how you may be able to avoid paying taxes on certain discharged items. A discharge refers to the forgiveness of a debt, or all monies owed to specific parties. You may owe taxes on properties not considered main or primary residences. The best way to know if you owe the government money is to work closely with individuals who knows bankruptcy.

By contacting the American Bar Association (ABA) website, these and other questions can be answered at the touch of a button. Additionally, some initial consultations may be free and there is locator that can provide you with information about lawyers who specialize in this type of law. Think before you act and be proactive in maintaining your new found financial wellness. Though you may be relieved of large debts themselves, those you owed still want to be provided with the money they would have collected from you, until you filed for bankruptcy.


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