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Do I Have to Pay Taxes on Settled Credit Card Debt?

Dealing with overdue credit card debt can be very stressful. It not only impacts your financial well-being but also your quality of life. The daily harassment from creditors can seriously affect your mental health. And, after a certain point, your unpaid accounts will also negatively impact your credit score. You may be thinking that it’s time to look into credit card debt settlement or even bankruptcy. Before you do, however, it’s important to understand the tax implications that may result from paying less than you owe.

What is Credit Card Debt Settlement?

Credit card debt settlement is an agreement between you and your creditor to pay off your debt for less than you owe. Generally, a creditor may agree to this arrangement if you are seriously delinquent or there’s little chance that the balance will ever be paid in full.

It’s important to note that credit card debt settlement will be included on your credit report. Your credit score will also decline. Although settling your debt is considered a negative action, it is still better than not making any payments at all. Additionally, you may also have to pay taxes on the amount of debt you no longer have to pay back. 

The Tax Implications of Settling Credit Card Debt

Once a creditor agrees to settle your debt, they will report the uncollected amount to the IRS as lost income. Since you no longer have to pay this amount to the creditor, the IRS considers it “other” income for which you’ll need to pay income taxes. Depending on where you live, you may also be required to pay state income tax on the forgiven amount.

Typically, you’ll receive Form-1099-C if the forgiven credit card debt amount exceeds $600 (not including interest and fees). You must report the amount on this form when filing your taxes. Even if you don’t receive the form, you should include any forgiven credit card debt on your tax return. Failure to do so could result in dire consequences (penalties and interest fees) if the IRS audits you at a later date.

Insolvency Exception

There are a few exceptions, such as bankruptcy, when it comes to reporting income from Form 1099-C. One of the most common is insolvency. If your debts exceed the value of your assets, you won’t be required to report the income on your tax return.

Example A: Your assets are valued at $40,000 and your debts total $55,000. You are considered insolvent with a $15,000 deficit. If your credit card lender agrees to forgive $10,000 off your balance, you won’t have to report any of it as income on your tax return.

Example B: Same scenario except that the credit card company writes off $20,000. In this case, you would need to report $5,000 as income on your return because it exceeds your insolvent total of $15,000.

If you are claiming insolvency, you’ll need to include IRS Form 982 with your tax return.

What If I Can’t Pay The IRS?

The income tax levied on settled credit card debt can be a burden for many taxpayers. Thankfully, you have a few options if you cannot pay the taxes owed.

  • IRS Payment Plan. You can set up a payment plan which allows you to pay off your taxes over several months or years.
  • Currently Not Collectible (CNC). If you are experiencing extreme financial hardship, the IRS may place you in a CNC status. No payment will be due until your financial situation improves. In some cases, it may be written off if the statute of limitations expires.
  • Offer in Compromise (OIC). Similar to credit card debt settlement, OIC allows you to pay off your taxes for less than you owe.

To learn more about your tax obligations due to credit card debt settlement or to apply for IRS tax relief, speak with a qualified tax professional.