An overwhelming amount of debt is alarming since you need to pay multiple EMIs at the same time. In such cases, there is a risk of forgetting to pay the EMI installations in a timely manner. As a result, the introduction of hidden charges and late fines increases your financial burden further. One of the proven ways of getting rid of an overwhelming debt is by applying for a debt settlement.
However, the debt settlement further comes with a significant additional charge. You need to pay the federal taxes on your debt settlement. The IRS imposes this tax, showing that the amount you do not pay is your income. So, how do you avoid paying taxes on debt settlement? Is there any possible way of avoiding taxes on debt settlement? Find answers to these questions in the following section.
Considering a Debt Settlement?
Are you considering a debt settlement to manage your overwhelming debt? There could be multiple ways of settling your debt. For example, applying for a debt settlement loan, also known as a debt consolidation loan, is a viable option. There could be multiple alternative methods to settle your overwhelming debt.
Instead of applying for a debt settlement loan, you can also try negotiating the debt amount with your debtor. Many credit counseling agencies offer non-profit debt settlement, though finding such options is difficult. Nevertheless, only a few people may find themselves qualifying for the non-profit debt settlement.
How Much Taxes Do You Pay for Debt Settlement?
The tax on debt settlement varies depending on multiple factors. The amount that has been settled is the biggest factor. Since the IRS views your unpaid debt as an income, it imposes the tax. Typically, you come under the taxation policy of the IRS if the debt settlement amount is more than $600.
The tax rate on the debt settlement is similar to the income tax rate. Let us check an example for a better understanding. Imagine that you have settled a debt worth $600. If you come in the 22% income tax bracket, your tax bill will be $132 ($600 x 0.22).
Is It Possible to Avoid Taxes on Debt Settlement?
Avoiding taxes on debt settlement could be possible under certain terms and conditions. Some debts do not involve a tax bill when they have been canceled. For example, you have borrowed some money from a friend or family member. In such cases, the debt settlement will not involve a tax bill since the money has been given on a personal term.
Besides this, there are a few additional exemptions in taxes on debt settlement. Find a few of those exceptions at a glance in the following section.
- When your debt gets canceled due to your bankruptcy, you will get a full exemption on the debt settlement tax.
- Sometimes, the lender may cancel a portion of your debt as a gift. For example, employers may cancel such debts of the employees, indicating that the canceled amount is a gift for the employee’s hard work or dedication.
- Student loan forgiveness as a part of the PSLF program is also exempted from taxation.
In case you are not sure whether your debt settlement is taxable or non-taxable, you should approach the IRS department. Alternatively, you can talk to a credit counselor or financial advisor.
Debt Settlement Alternatives
If you want to avoid paying taxes on debt settlement, you may consider the following tips and tricks discussed below.
- Debt Consolidation Loan: Instead of applying for forgiving your debt, you can apply for a debt consolidation loan. While applying for debt forgiveness will have a long-term impact on your credit score, debt consolidation has a short-term impact on your credit score. As soon as you repay the loan, your credit score will observe a sharp jump.
- Filing Bankruptcy: Instead of seeking debt settlement, you can file a bankruptcy. Declaring yourself bankrupt will lead to a poor impact on your credit score. However, the advantage is that all your unpaid debts and bills will be settled instantly. In the future, you will have difficulty getting a loan from the lenders.
- Credit Counseling: Approach a credit counselor when you do not know the best option for your debt settlement. The most aggressive credit repair company may suggest a debt consolidation loan to keep your creditworthiness intact in the long run. However, it is not the best solution in all situations. So, consult a professional and reliable credit counselor near you.
Bottom Line
So, these are the things that people should know if they want to avoid paying the debt settlement tax. Following the right guidelines of a professional advisor for credit repair in Sacramento will eventually help you maintain a good credit score by planning your debt settlement with precision. Choosing the right option for debt consolidation or settlement is essential for a secured financial future.
