In general, if you have debt-cancellation income because your debt is canceled, forgiven, or forgiven for less than what you must pay, the amount of the debt canceled is taxable and you must declare the canceled debt on your tax return for the year the cancellation occurred. However, cancelled debt is not taxable if the law specifically allows it to be excluded from gross income. These specific exclusions will be discussed later. Legally, you must declare all the taxable income received and this includes the amount of the settlement of your debt.
If you are issued a 1099-C, the IRS will also receive an income notice and you may be penalized for not reporting. You'll have to pay not only the taxes you owe, but also the penalties. After you cancel a debt, the creditor can send you a Form 1099-C, Cancellation of Debt, showing the amount of the debt cancellation and the date of cancellation, among other things. A debt settlement company will recommend a new monthly payment, which you will deposit into an account that allows access by third parties.
How long debt settlement stays on your credit report is also related to how it affects your credit rating. If you borrow money and are legally required to repay a fixed or determinable amount at a future date, you have a debt. In general, if you exclude debt canceled from income under one of the exclusions mentioned above, you must reduce certain tax attributes (certain credits and extensions, losses and extensions, asset base, etc. Debt settlement or debt forgiveness is a last resort option that can help debtors get out of overwhelming balances).
When you study these exemptions and exclusions, be sure to work with a certified tax professional with experience in debt settlement. Your responsibility to declare the taxable amount of the canceled debt as income on your tax return for the year the cancellation occurred does not change whether or not you receive the correct Form 1099-C. Delinquent debt can affect your credit history, but working with a debt settlement professional is one way to let go of the past. You can pay off your debt for less than you originally owed, but you'll have to claim the forgiven amount as taxable income.
Even if you don't receive a 1099-C, the law may require you to declare the canceled debt as income. However, when a significant portion of the debt is forgiven, the IRS collects taxes on the difference between what is due and what was actually paid. The IRS considers that the part of your debt forgiven after debt settlement is income and therefore taxes you for it. However, the law provides for several exceptions where the amount you don't have to pay is not a cancelled debt.
In debt settlement cases, you incurred the debt, so removing it from your credit report doesn't provide an accurate picture of your credit.
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