When too much debt takes over many people seek debt relief through bankruptcy, debt negotiation or debt settlement options. The concern that people have with debt settlement or debt negotiation is whether or not they will have to pay taxes on the amount of the debt that they did not have to pay back.

According to the Internal Revenue Service any debt that is cancelled that resulted in a savings of $600 or more must be reported on a 1099. This would mean that the amount of the debt that was negotiated off could be a taxable event and have you owing money to the IRS. If you happen to be in this situation, there are two reasons why this won’t affect you that much.

Determine What Taxes You May Owe After Debt Settlement

If you can show that you are financially insolvent, you will not be required to declare cancelled or settled debts as income. This is according to IRS Publication 908. You must owe more in debt than you have in assets at the time of the debt negotiation settlement with your creditor. This would also mean that you would only pay tax based on the amount of solvency you have. For example, if you save $20,000 when you only have $6000, you would only pay taxes on $6000.
The reality is that most people have more debt than they have in savings when they enter a debt negotiation program anyway. I would recommend that you speak with a tax professional first to know where you would stand prior to entering the debt settlement program. This way you would not have any surprises regarding the exception on having taxable income.

You May Save Money By Paying Taxes On Debt Settlement

What if you have a taxable event and are issued a 1099 from your creditor? You still saved a lot of money. The IRS will only tax you on the additional income and you will have to only pay a percentage of what you have saved and not the entire amount. If you save $10,000 in the debt negotiation process and are taxed $2000 you still saved $8000. No matter how you slice it, you still come out ok.