Please check my 3/7/13 posting on 1099-Cs for important updates!
I’m currently working with a client who is considering settling debts and concerned with having to pay income tax as his accounts are still owned by the original creditors. So I did some research and I just reviewed the current rules.
As always, I’m NOT an attorney or CPA — please read the IRS instructions yourself and/or retain competent professionals if you can locate any and have the resources to pay them.
You may have to pay income tax on “discounts” received when settling debts as the law requires creditors to report to the IRS debt cancellations of $600 or more.
Example:
You owe $10,000 and you settle for $3,000.
If the entire balance was for PRINCIPAL, you would have to pay income tax on the $7,000 discount — if you are not “insolvent.”
Due to the depressed housing market, MANY people who would never consider themselves “insolvent” in fact ARE insolvent for tax purposes.
It simply means that your liabilities exceed your assets and it has NOTHING to do with having too much money in the bank or in retirement funds or having a well paying job.
It just means that you owe more than your property is worth if you tried to sell it.
Keep in mind that the value of your property is NOT what you paid for it, but what you would RECEIVE if you tried to sell it.
I’m NOT trying to encourage anyone to settle debts, but for SOME people it is the right thing to do if settlement will actually increase their FICO scores and/or they need good credit, such as people with security clearances.
Don’t pay more taxes than you legally owe.
Here are some relevant links: (more…)