Settling A Debt For Less Than You Owe
Paying a reduced amount to creditors could mean owing the IRS
For Immediate Release: February 27, 2003
ROCKVILLE, Md. — When facing hard times, settling a debt for less than you owe can make good financial sense, but it can also come back to haunt you. "When you settle a debt or if a creditor forgives a debt by writing it off, the amount that was forgiven needs to be reported when you file your taxes," said Mike Kidwell, vice president and co-founder of Myvesta, a nonprofit financial management organization. "The amount is considered income since it was originally loaned to you but now you do not have to pay it back."
After settling a debt your creditor should send you and the Internal Revenue Service a Form 1099-C or 1099-A at the end of the year. Both forms are for the reporting of miscellaneous income. When you file your taxes you'll need to record the amount on those forms along with your income for the rest of the year.
"Even if your lender didn't send you the proper form, you don't want to gamble that they didn't send it to the IRS," Kidwell said. "If you don't report that income and the IRS was notified of it, you might be sent a tax bill or even worse an audit notice."
Kidwell mentioned these situations where a settled or defaulted debt needs to be recorded as income:
- A mortgage lender forgives the balance owed after a short-sale of a home or a foreclosure sale;
- A car lender forgives the balance due after a repossession sale;
- A credit card issuer takes less than the full amount owed on an outstanding bill; and
- You have defaulted on a loan and the debt was written off.
For a more in-depth look at your tax liability after settling a debt, read the Myvesta publication "Beware of the IRS if You Settle or Default on a Debt." It can be downloaded from Myvesta.org online.
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MyvestaSM is dedicated to helping people create healthy financial lives. The organization provides a wide range of materials to inspire and inform people so that they can break down their barriers to financial and personal success. For more information visit Myvesta.org online.
