Debt forgiveness comes in many variations. It is one thing to say to someone they don’t owe you money anymore. That sounds so simple and easy.
Life doesn’t work like that.
In the United States, when a creditor forgives debt you owe the Internal Revenue Service (IRS) is very interested. If you are not broke, the IRS will expect you to pay income tax on the debt forgiven.
While you may no longer owe the creditor, you will now owe the IRS.
But like everything else the IRS does the details are the critical issue.
If your debts exceed your assets, then you are insolvent. And if your assets minus your liabilities leave you worth less than zero, you can complete IRS Form 982 not to have to pay that tax.
Not All Debt Forgiveness is Equal
Your forgiven debt tax liability may not exist depending on how your debt vanishes.
Debt settlement can leave you owing the IRS when your assets are more than your liabilities. Positive net worth will give you a full or partial tax bill and some attention from the IRS.
Bankruptcy eliminates debts tax-free with no tax liability. That benefit is written into the law by Congress.
A creditor can reduce your interest rate and the reduction in interest to be charged is not a tax liability. This interest rate reduction may be a benefit of a credit counseling program with a non-profit agency. But you will repay significantly more than you would through debt settlement or bankruptcy.
Consider Your Selection of Debt Forgiveness
Understanding if or how much of a tax bill you can have when you have forgiven debt is essential to better understanding which debt forgiveness option to select.
Too often people decide how they would like to cut their debt before they have all the facts such as a looming tax liability.
When you talk to a debt relief company, understand the person you are talking to is a salesperson and not a financial adviser. To better understand how your debt forgiveness option may increase your taxes, talk to a tax professional.
And this issue of tax liability from debt forgiveness gets even more confusing when it comes to student loans.
Some student loan forgiveness programs like the Public Service Loan Forgiveness program will end your debt tax-free. Other programs like an income-driven repayment plan will leave you with a massive tax bill.
Mortgage debt forgiveness even has it’s own unique set of issues.
As with everything else when it comes to getting out of debt, get professional help and advice before you make an expensive mistake.