What Are The Tax Consequences Of Debt Settlement?

Last Updated: February 23, 2024

If you are forgiven $600 or more of the original balance, not including interest and fees, the creditor may send you a 1099-C form at the end of the tax year. The amount on this form is now considered income and must be reported to the IRS. The creditor will report it to the IRS in order to lower their tax burden.

If you do not get a 1099-C, don’t assume the IRS doesn’t know about the write-off.

Your creditor may of submitted one to the IRS at some point. If you don’t declare the deficiency balance, you may receive a tax bill plus interest and penalties. And here’s a fun fact about the IRS, they may forgive your tax burden, but they usually don’t forgive your penalties and interest!

How does a 1099 C affect my tax refund?

A 1099-C may affect your tax refund depending on your income and other taxable considerations. Talk to a tax professional if you are filing a 1099-C and see if you qualify for an exception.

What to do if you receive a 1099 C Form?

If you have received a 1099-C from one of your creditors, you need to report the settled debt amount to the IRS as income. You could always ask the creditor yourself if they intend to file a 1099-C with the IRS.

How Much Tax Do You Pay on Forgiven Debt?

The amount of tax you pay on charged off debt depends on your unique situation and your marginal rate of tax. You are considered insolvent if your liabilities exceed your income when you settled the debt. Ask a qualified tax specialist if you can take an insolvency exemption and get your tax debt forgiven.

Debt Settlement or Write-off Tax Consequences

If you are in a debt settlement program, remember that you may have to pay taxes on forgiven debt. Find out if the creditor will be submitting a 1099-C, and if so, the exact amount they will declare on it. Next, keep your eye out for the form after the first of the year. And finally, make sure the 1099-C is correct before you submit it to your tax specialist. If it isn’t, contact the creditor to have it corrected.

If you are curious how much you may

 owe, check out a debt forgiveness calculator to get an idea. Remember that this is based on simple information and may not be absolutely correct.

Debt Settlement and Your Credit Score

You will most likely see a negative effect on your credit score from debt settlement but most likely at this point you are already having difficulty paying your bills and may already be experiencing a drop in your FICO score, otherwise known as your credit score.

The good news is once you complete our debt settlement program you can then work to improve your credit score and repair your credit. Our debt settlement program can last years to help you reduce your debt so if maintaining a high credit score is your priority, debt settlement might not be for your current financial situation.

You can find out your credit score on any one of the credit bureaus. Once you can access your latest credit report, you can see all the items on your credit. You should check your credit report often to see if anything has changed. If your credit score drops from good credit to bad credit, you’ll want to know about it immediately.

You should also keep a watchful eye out for identity theft. Identity theft is rising rapidly and can ruin your credit. Always look out for negative information and make sure it's correct. If you see incorrect information on your credit report you need to dispute it right away.

The Debt Settlement Process and Timeline

A debt settlement program usually takes between 2-4 years to complete. Here is a typical timeline:

• Month 1: You stop making payments to creditors and start setting aside funds. We help you calculate the right amount to save.
• Months 3-6: We initiate negotiations with your creditors. Offers usually start coming in around month 6.
• Months 6-24: As we reach settlements, funds need to stay set aside until enough accumulates to make settlement offers. During this time, expect late payments and defaults on your credit report.
• Months 24-48: In the second half of the program, most settlements occur. By month 48, you can usually see the light at the end of the tunnel.
• It's critical to stick closely to the program during these 48 months. Failing to set aside funds means not having enough to reach settlements.

For more details,  check out our debt payoff calculator to estimate your timeline.

How Debt Settlement Impacts Your Credit

Debt settlement often hurts your credit score, but the severity depends on your situation:

• Missed payments and defaults will be added to your credit report once you stop payments. This can cause your score to drop 100 points or more.
• As debts get settled, they will be marked "Paid Settled" on your report rather than "Paid in Full".
• Your credit utilization ratio will decrease over time as debts shrink, helping your score.
• Rebuilding credit after debt settlement can take 1-2 years of careful financial habits.

Here are some tips for recovering after debt settlement:

• Get a secured credit card and use it responsibly to prove you can handle credit again.
• Limit new credit inquiries while rebuilding score.
• Maintain low revolving credit utilization.
• Consider credit repair services to help remove negatives.

Alternatives to Debt Settlement

While debt settlement is one option to become debt-free, other paths exist too:

• Debt Management Plans: A DMP provided by a credit counseling agency can help arrange reduced interest rates and flexible repayment plans with your creditors. This protects your credit score more than debt settlement.
• Debt Consolidation Loans: These combine multiple debts into one, letting you pay everything off at a lower interest rate. This helps make debts more manageable without damaging credit scores.
• Bankruptcy: As a last resort, personal bankruptcy immediately eliminates most debts. While hurting your credit initially, it provides a fresh slate to rebuild credit after a few years.

FAQs

Conclusion

Debt settlement can be a helpful option for becoming debt-free, but it's important to consider the potential impact on your finances and credit. The process usually takes 2-4 years to complete and settled debt often has tax consequences.

While debt settlement provides relief from burdensome payments, alternatives like debt management plans and loans could be better solutions depending on your situation. As you explore your debt relief options, be sure to understand the pros, cons, and credit implications of each path.

Reach out to a professional like Pacific Debt for tailored advice and to fully grasp what debt settlement entails. With hard work, financial discipline, and the right debt relief strategy, you can overcome debt burdens and work toward financial stability

Pacific Debt Relief

If you’d like more information on debt settlement or have more than $10,000 in credit card debt that you can’t pay, contact Pacific Debt, Inc. We may be able to help you become debt-free in 2 to 4 years. We have settled over $250 million in debt for our customers since 2002. We rate very highly in Top Consumer Reviews, Top Ten Reviews, Consumers Advocate, Consumer Affairs, Trust Pilot, and US News and World Report.

Pacific Debt is currently providing debt relief coverage in the following states:

Alabama, Alaska, Arizona, Arkansas, California, District of Columbia, Florida, Hawaii, Iowa, Idaho, Indiana, Kentucky, Louisiana, Massachusetts, Maryland, Michigan, Minnesota, Missouri, Mississippi, Montana, North Carolina, Nebraska, New Mexico, New York, Oklahoma, Pennsylvania, South Dakota, Texas, Utah, Virginia, Wisconsin

For more information, contact one of our debt specialists today. The initial consultation is free, and our debt experts will give you all your options.

*Disclaimer: Pacific Debt Relief explicitly states that it is not a credit repair organization, and its program does not aim to improve individuals' credit scores. The information provided here is intended solely for educational purposes, aiding consumers in making informed decisions regarding credit and debt matters. The content does not constitute legal or financial advice. Pacific Debt Relief strongly advises individuals to seek the counsel of qualified professionals before undertaking any legal or financial actions.