One of the most questioned topics at Credit Monkey seminars is forgiven debt.
I preface every discussion about negotiated settlements of debt with a warning about being prepared to pay taxes on forgiven debt. According to the Internal Revenue Service, forgiven debt is realized income. That means that every penny you save when negotiating with a creditor is like a penny earned from an employer and you may need to pay income tax on those “earnings”. The IRS requires that when any debt of $600.00 or more is forgiven, the firm forgiving the debt must provide you and the IRS with a Form 1099 so you can pay taxes on the realized income.
You just spent every penny you had fixing your credit and now you are required to pay taxes on the great deals you made. Unfortunately, the answer is yes, but not in every case. If the debt was discharged in bankruptcy, no tax should be paid on discharged debt. Also, if you are insolvent, the tax should be forgiven. Wikipedia defines “Insolvency” as the state of being unable to pay the money owed, by a person or company, on time; those in a state of insolvency are said to be insolvent.
There are a few other narrow exceptions to the Forgiven Debt Dule, but each should be discussed with a Certified Public Accountant and not a tax preparer.
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