Posts Tagged ‘debt settlement’

Debts Discharged in Bankruptcy Are Not Taxable

Debts Discharged in Bankruptcy Are Not Taxable


If you settle a debt for less than you owe, the balance canceled or forgiven by the creditor must be included in your gross income on your tax return. The creditor will send you an IRS Form 1099-C for Cancellation of Debt, and you must report the cancelled debt as taxable income. In fact, you must report the taxable amount of a forgiven debt even if the creditor does not send you a 1099-C.

Credit cards, personal loans, foreclosures, short sales — any debt settled for less than the full balance — can create a huge tax liability.

It’s important to determine how settling a debt will affect your gross income. Settling a debt versus discharging a debt in bankruptcy often has the effect of simply exchanging a private creditor for the IRS, which has vastly more powerful collection powers.


Outside of bankruptcy, any forgiveness of debt is your taxable income. But debts discharged in bankruptcy are not taxable. Discharged debts are tax-free.

The bankruptcy discharge is given special treatment in the tax code because Congress wanted bankruptcy debtors to get a fresh start on their finances. The bankruptcy discharge carve-out is contained in Internal Revenue Code Section 108.

Unlike settled debts, debts discharged in bankruptcy are non-taxable, so when it comes to taxes, filing a Chapter 7 bankruptcy or Chapter 13 bankruptcy will be almost always be preferable to debt settlement.

In some less common cases, discharged debts may reduce “tax attributes,” such as loss capital loss carry-forwards. In those cases, an IRS Form 982 should be filed. (For more information on this, see IRS Publication 4681). In general, though, those do not affect most of my clients. I always recommend consultation with an accountant in the tax year following your bankruptcy discharge.


Debts discharged in bankruptcy are not taxable. Debts you settle for less than what is owed are taxed. If you want to understand your different bankruptcy options, seek out the personalized legal advice of the bankruptcy attorneys at Lee Legal.  We are a debt relief agency. We help people file for relief under the Bankruptcy Code.  To schedule a free financial analysis, call (202) 448-5136.

Debt Collection Companies and Negotiating Debts

For all of the harassing debt collection calls and for all of the threatening letters that my clients receive, it’s amazing how many of these calls and letters come from just a few debt collection agencies. Bank of America, Citibank, American Express, Chase, Wells Fargo, and virtually every other lender send all of their default or delinquent accounts to a relatively small number of large debt collectors. Here’s a partial list of those who call, and call, and by whom you may be sued by:

  • Asset Acceptance
  • NCO Financial
  • Glasser & Glasser
  • Midland Funding
  • Encore Capital
  • Portfolio Recovery
  • LVNV Funding
  • Unifund and eCast
  • Fulton Friedman & Gullace
  • Arrow Fiancial
  • Resurgent Capital
  • Palisades and CACH
  • MCM Holdings
  • Protas Spivak

If you have ever received a call or letter from one of these companies, you know how aggressive they can get. “How much can you pay today?” they ask. “The last time we spoke, you told me that you were trying to get the money together.” Do they care that you’re at work? Not really. Do they care that your income and expenses don’t allow a payment on their debt, often one that you incurred years ago? Not in the slightest. “Any payment, even a small payment, will help your standing with us.” Don’t fall for it.

In some cases, these companies will settle your debt with you for some percentage of the amount owed, and in some cases, this can be a good deal for you. But to take advantage of a settlement offer, you will need to come up with a “lump sum,” that is, payment in full on the settlement amount, usually within 7 days. And you will usually have to be in default with them for a long time to get an offer at all.

For instance, if you owe $12,000 to American Express and a Midland Funding representative offers you a 45 percent settlement, you will need to come up with $5400 within a week (or at most two) to take advantage of that offer. Most people whose accounts are in collection do not have that kind of ready cash on hand. If you have many of these kinds of debts, you may want to consider filing bankruptcy.

Collection reps will be happy to work out payment plans for you, but on extended payment terms they will insist that you repay the debt in full. Of course, if you do have some cash reserves and would like to settle a debt, I recommended that you retain an attorney to negotiate and review the terms of the settlement before you make or accept any offer with a debt collection agency. Do not use a debt settlement or debt consolidation service. Those companies are, in the vast majority of cases, absurdly ineffective.

My clients occasionally report horrible violations of the Fair Debt Collections Practices Act. The most egregious of these violations is the threat to commence criminal action. Debt collection is a civil matter. You cannot be charged for a crime for owing a debt, nor can you cannot go to jail for failing to pay a debt. Debt collection is a civil matter, not a criminal matter. Debt collectors can expose themselves to serious liability for violations of the FDCPA. If a debt collector is getting too aggressive with you, call my office.

Most Debt Settlement Companies are Rip-Offs

While there is no independent research into the success rates of so-called “debt settlement” companies, company reports and anecdotal evidence suggest that fewer than one in four of those who hire these companies actually complete their programs.  Even more troubling, up to 10% of debt settlement clients are sued by their creditors while in a debt settlement program.  Here’s the way these companies are supposed to work.  

Debt Settlement Companies Are RipoffsFirst, the debt settlement company gets paid.  They typically charge several hundred dollars as an initial “administrative fee” to set up your account.  In addition, they will charge you a monthly service fee.  The company requires a monthly payment, however instead of sending this money to your creditors, the company keeps your money in trust until there is enough to pay a creditor either the entire balance of your debt, or some agreed-upon reduced amount.  

Unfortunately, this process can take several years to complete, depending on the number and amount of debts you owe.  In the meantime, your creditors can sue you, garnish your wages, and continue to harass you.  In addition, during the entire “debt settlement” process, interest and fees will continue to accrue.  It is not very surprising that so few of these programs succeed. 

The Washington Post recently reported that debt settlement scams are on the rise.  Advocacy groups say the industry’s advance-fee model and lack of regulation have allowed unscrupulous firms to take advantage of desperate customers.  Bankruptcy is very frequently a much better option.

People do not choose to put themselves into unfortunate financial situations, but debt settlement companies often make bad situations worse.  These companies collect huge fees, grow debts, damage credit scores, and in the end, typically fail.  Bankruptcy, on the other hand, offers immediate protection from collection efforts, ends garnishments and lawsuits, and allows you to start getting your finances back on track almost immediately.  The typical Chapter 7 also takes about three months to complete, which is far less time than the typical debt settlement plan.   

If you are considering either debt settlement or bankruptcy, a good first step is to schedule a free consultation with a bankruptcy lawyer.  Licensed in Washington, D.C. and Virginia, attorney Brian Lee can help you assess your financial options.  Call 202-448-5136 or email

Alternatives to Bankruptcy

The decision to declare bankruptcy is usually a difficult one.  To get started, I thought I would lay out the alternatives to bankruptcy, namely Budgeting, Credit Counseling and Debt Settlement.

BUDGETING:  If you can find a way to pay your bills on your own, then you should try to calculate how long it will take to become debt-free.  You should attempt to design a feasible budget that pays more than the minimum payments toward the debts.  At the same time, you cannot sacrifice the health and welfare of yourself and your family.  Dependent upon your income and debts, a budget that pays at least triple the minimum monthly payments toward unsecured debts (such as credit cards) might take more than 20 years to completely pay.

CREDIT COUNSELING:  A good credit counseling service should determine your income and expenses and help you fashion a workable budget, if possible.  Credit counseling services often bad-mouth other debt reduction alternatives (i.e., they sometimes say “bankruptcy is a 10 year mistake”).  If the credit counseling service suggests you see a bankruptcy attorney, or if the payment amount they come up with is too high, then bankruptcy may be a good option.

DEBT SETTLEMENT:  Attempting to settle your debt usually requires a sizeable amount of cash.  Many people use an attorney for this since there are many pitfalls to debt settlement.  If you can come up with cash (i.e., from a home refinance, tax refund check, inheritance, personal loan, etc.) then frequently you can settle your debt for 40% to 60% of your balance.  You must get whatever agreement you obtain in writing prior to sending money.  Two caveats.  First, many of my bankruptcy clients tried debt settlement and were simply ripped off by the companies.  There are a lot of companies out there that will take your money and never produce any results.  If you feel debt settlement is right for you, check up on any professional or company you are considering retaining with the Better Business Bureau.  And the second caveat: The IRS considers forgiven debt to be taxable income.  Thus, if you settle $100,000 of debt for $60,000, then you may owe taxes on the $40,000 that was forgiven.

If none of these options work for you and you are treading water or sinking financially, then bankruptcy is probably a good idea for you.  Every situation is different, however, and you should talk with a professional who can help you assess your options.

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