The average U.S. household has more than $100,000 worth of consumer debt, and millions of Americans seek relief from it each year. Many also wonder, “Does debt relief affect your taxes with the IRS?”
The answer to this question is, “It all depends.” The type you choose will ultimately determine whether or not it impacts your taxes.
Let’s look at several common forms of relief and break down how each will affect your taxes.
A recent Global Financial Literacy Excellence Center report revealed that over half of American adults struggle to score at least 50% on a financial literacy test. If you fall into this category, signing up for credit counseling services may change this.
During credit counseling, you will learn to do everything from creating a monthly budget (and sticking to it) to managing your money more effectively. This should, in turn, allow you to better deal with your debt.
However, credit counseling does not deliver immediate relief and, therefore, does not impact what you owe to the IRS.
People typically have at least a few different types of debt hanging over their heads. These debts stem from credit cards, personal loans, car loans, student loans, mortgages, etc.
Some people consolidate their debts to make them more manageable. This process involves combining all the balances they owe creditors and securing a better interest rate, making repayment easier.
In rare cases, consolidation will cause the answer to “Does debt relief affect your taxes?” to be “yes.” But more often than not, it will not impact the amount people owe the IRS.
If you can’t conceivably repay all the money you owe to creditors, it is worth looking into settling your debts with them. In many cases, an experienced negotiator may help you settle them for significantly less than what you owe.
Before taking this approach, make sure you know about its potential tax implications. Any overdue balances that creditors forgive will increase your gross income and tax responsibilities.
Creditors who agree to cancel debts worth $600 or more must send you a 1099-C Form, utilized to report cancellation of debt (COD) income, at the end of the year. When filing your taxes, you need to report the taxable forgiven debt listed on this form.
The debt settlement tax consequences won’t affect everyone equally. If, for example, a taxpayer’s liabilities outweigh their assets, they may qualify for an insolvency exclusion. This will prevent settlements from increasing their gross income and impacting their tax filings with the IRS.
Filing for Chapter 7 or Chapter 13 bankruptcy will turn your world upside-down in various ways. It may limit your ability to borrow money for the foreseeable future. However, it won’t impact the taxes you owe as much as you might think.
While filing for bankruptcy discharges debts in many instances, you can usually exclude it from your gross income by filing Form 982 with the IRS.
Still, working closely with tax professionals after filing for bankruptcy is a great idea. They will advise you on how to handle bankruptcy debt discharges without them taking too much of a toll on your finances.
Unfortunately, there isn’t a one-size-fits-all answer to the question, “Does debt relief affect your taxes?” The type of relief you choose will dictate its impact. Contact Levy & Associates, Inc., at 313-447-1704 or fill out this form to speak with a trusted tax professional.
Levy & Associates is available for free initial consultations. We’re happy to answer any questions you have about the audit process or address any concerns about your specific situation.
There’s never a good time to be audited, and the time-consuming process will take away from your business or family if you try to face it alone. Let us handle and coordinate communication, so you can return to your daily life.