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Is This Really Going to Be My Tax Liability When I Settle My Debt? – Joe

By on January 18, 2013

“Dear Steve,

I understand that there may be tax liabilities on a Debt Settlement if you’re not Insolvent at the time. I know you’re not a Tax Man, but can you help me see if my assumptions are correct?

$50,000 of Debt increases to $55,000 by settlement

Settle at 40% = $22,000

Forgiven Debt Income = $33,000

Wife and I make $49,000 combined

$33,000 plus $49,000 = $82,000 total income

That would move us up to the 25% tax bracket so
25% taxes on the $33,000 Forgiven Debt = $8,250

That’s a lot to be added back into the settlement benefit. If this is close to being right, I think I’m gonna need to work at my negotiation skills to get better settlements!

Joe”

Dear Joe,

If you are not insolvent at the time you start the settlement, the math appears to be correct.

It is my understanding the tax liability is only on that part of the debt above the point where you become insolvent.

So if you are currently insolvent and would be up until the point you settle fifty percent of the outstanding debt for example, then you’d only owe income tax on $16,500 of the forgiven debt above the point where you became solvent.

This is not a matter of being a better negotiator but using the right debt relief tool at the right time. It’s one of the reasons that bankruptcy makes so much sense for so many people. None of the forgiven debt is taxable.

Do you have $22,000 cash on hand to settle with? If not, where are you planning to get the funds?

Please post your responses and follow-up messages to me on this in the comments section below.

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About Steve Rhode

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

3 Comments

  1. Joe

    January 21, 2013 at 3:26 pm

    I will have to consult with a tax adviser about the insolvency. It seems like it will be real close in my case. The mortgage on the house is seems to be equal to what it’s worth on the market. There’s no savings. The household items and cars are worth less than the amount owed to the credit card companies.

    I think that debt settlement is the best option for me. I will have most of the $22,000 by the time these charge of. If they let me make the payments over 90 days then I will have enough for sure.

    • Steve Rhode

      January 21, 2013 at 3:30 pm

      Depends on how much you want to pay income tax on the forgiven debt. So the house is a wash, you’d have to look at your other liabilities then. If you don’t have any then it would appear the full amount of the forgiven debt would be taxable.

      This is one of the benefits of bankruptcy, no tax liability.

      • Charles Phelan

        January 21, 2013 at 5:00 pm

        Steve, even if Joe’s house is a wash, the full $50k of the CC debt is still a liability for the purpose of calculating insolvency. Depending on the value for the autos, etc., he may still be able to show insolvency, at least for some of the settlements (if not all).

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