Debt Settement and Taxes - Bolinske Law
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Debt Settement and Taxes

Debt Settement and Taxes

In nearly all my dealings with client I hear a common statement at the first meeting, “I want to or tried to pay back my debt.”  The statement runs contrary to what many will believe about individuals who find themselves in financial trouble.  Many options do exist for individuals who would like to pay back debt.  The key like anything is to find ensure that the best option is used.  Many debt settlement, debt consolidation companies earn huge profits on the desire to pay back debt.  Unfortunately what many debt settlement companies don’t tell their clients are the pitfalls of debt settlement.

Two basic types of debt settlement exits.  The first negotiates for a fee on a lump sum settlement.  The second offers a payment plan to creditors over a term of years.  In the lump sum option debtors will either make monthly payments to the debt settler until a sum is large enough to offer a settlement or individuals will give a lump sum at one time to settle the debt.  In the payment plan option interest and fees often continue to accrue.  Many payment plans also require a confession of judgment, meaning if the plan is broken the creditor can take judgment without notice or hearing.

In either case the difference between amount the debt is settled for and what was originally owed is taxable.  What can happen is individuals go from owing Discover, Capital One, CitiBank, HSBC to owing the Internal Revenue Service (IRS).  In addition to the taxation on the settled debt many individuals also draw from retirement savings to offer the one time settlement.  The early drawing from retirement creates another taxable event.  Retirement funds taken early are taxed at the income tax rate plus ten percent.  Great caution needs to be taken to ensure that the debt settlement is going to be a help.   Actual numbers need to be calculated to ensure that the settlement is payable with the tax implication.  There is no benefit if you are jumping out of the hear and into the frying pan.  Owing the IRS is in most cases worse that owing a credit card company because the IRS has super collection powers.

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