Debt Settlement Tax Consequences

The tax consequences of debt settlement are not significant for most people. Furthermore, people who do need to pay taxes on their settled debts generally find that they pay much less in settlement and taxes than they originally owed on their debts.

Debt Settlement

Debt settlement works by allowing you to pay off a portion of your debt and have the rest forgiven. Creditors agree to accept part payment of your total debt - usually about 50% - and then consider the balance forgiven. If applicable, you will then owe taxes only on the forgiven amount.

Taxes on Forgiven Debt

Some debtors will need to pay income taxes on the forgiven debt amount. This only applies to people who are still solvent, that is, who still have positive net worth. For example, if you have equity in your home or other property, you would be considered still solvent and would have to pay taxes on your forgiven debt. However, the amount of the debt paid plus taxes will still be less than what you originally owed.

Insolvency

Most people who settle their debts do not have to pay taxes on their forgiven debt. This is because they are insolvent, meaning that they owe more than they own. Therefore, taxes are not applicable because the debtor would not be able to pay them anyway. 

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