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Be Aware of Different Tax Implications when Settling Your Debts

    1. when tax implication can occur
    2. tax implications for different forms of debt settlement

When you as a borrower consider to arrange debt settlement in any form, should it be debt consolidation, debt cancellation, debt renegotiation or other, you should not forget a crucial part that come as a result of it – taxation.


It may sound very frustrating, but very often borrowers are unaware of tax implication for debt settlement when they get involved in the process at early stage. Since in United States debt settlement can come in different forms mentioned above, let us consider several implications that you should be aware of.


If you are settling debt by renegotiation the total amount with the lender, there is a possibility that you would reduce total amount outstanding. In terms of tax implications, it can be considered as a type of taxable income on a form of gain from the reduction of debt via debt consolidation. In United States the only exception how you can avoid it is to file for personal insolvency or, in other words, bankruptcy. It may sound unfair, but according to the state law, renegotiated debt settlement for lower amount than the original is subject to state tax.


Some of the borrowers worry that even if they cancel the entire amount of debt, they will be taxed. It is partially true. Be prepared to pay tax bill if you negotiate with the fund provider, such as credit card operator, to write off your debts. This results in tax liability for cancelling large amount of debts. The trouble is that it often comes as a surprise to many borrowers involved in debt settlement in United States. Moreover, the tax liability remains registered after failed borrower regardless of whether he or she has received special Debt Cancellation Form 1099 from the fund provider at the end of taxation year.



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Finally, if you are participating in debt settlement via debt consolidation, there are following tax implications to expect. Considering that debt consolidation would more often than not involve your property being used as collateral for new consolidated debt, the concept of debt settlement would work more as “refinancing your mortgage” option.


In order to make debt consolidation worth getting involved in, total financial benefits should out weight total potential costs. Debt consolidation is very likely to reduce your monthly interest rates payments and increase the maturity of total debt. Now, what many borrowers tend to forget is that payment of interest is deducted from your taxable income and, thus, automatically decreases the total tax bill on your behalf. Assuming that you would significantly decrease accumulated interest payments over years, it can also result in much larger accumulated tax payments.


Nowadays, there are many software applications online that help you to calculate all the benefits of different forms of debt settlement and debt consolidation including tax implications for different types of debt settlements. Prior to getting involved in any form of debt settlement, it is wise to make a proper research and make sure that you are fully aware of realistic effect on debt settlement on your final tax bill.

  • References:


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