

     This is a common question that comes from many of my clients. Their thinking is, “What’s the point of discharging debt if I’m going to get taxed on it?”. This is a great question and an even better concern.      You have to understand the difference between “cancellation of debt” and Discharge of debt”. Cancellation of debt is a taxable event, whereas discharge of debt is not a taxable event. Let’s look at an example. You owe ABC Debt Collectors $20,000.00 in debt. They make an offer to settle the debt for a lump sum of $7,000.00. You think, good deal. You promptly find the money and pay off the debt. Your got rid of the debt and are free. Not so.      Fast forward to the end of the year. ABC Debt collector has written off $13,000.00 off their books ($20,000.00-$7,000.00), thus creating an additional expense that can be written off against their revenue. To offset this credit, ABC Debt Collector is required by IRS law to send you a 1099-C for the $13,000.00 in debt they cancelled. This form will be filed with the IRS and must be reported as income and taxed at your normal income tax rate. So if you are at a 25% tax bracket, then you have a tax hit of $3,250.00 ($13,000.00 x 25%). You have paid $10,250.00 to settle a $20,000.00 debt. You will get a credit rating hit, as the cancellation of debt is reported to the credit reporting agencies. This is just for one creditor. If you have multiple creditors, well, you can do the math.      Let’s say you file Chapter 7 on the $20,000.00 in debt. You will pay a bankruptcy attorney (or should) significantly less than the $7,000.00 (around $1,700-$2,000) to handle your entire bankruptcy case and take care of all your creditors. This will include ABC Debt Collectors and everyone else you owe. Within 3-4 months, you receive a discharge order from the bankruptcy court “Discharging” all your debts, not cancelling your debts. This is the Federal court system telling you that your debts are gone and no longer owed. Under bankruptcy law, discharged debt is not taxable for any purpose. If you do receive a 1099-C from your debts discharged in bankruptcy, speak to your tax professional right away. If you need a tax professional, just call me and I would be happy to refer one to you.      Let’s say you file for a Chapter 13, you would pay around $3,000-$4,000 to your attorney and you have to pay your unsecured creditors 10% (remember, in a Chapter 13 there are no late fees, penalties, or interest adding to your account each month). You will pay back ABC Debt Collectors $2,000 ($20,000 x 10%). The balance of $18,000.00 will be discharged ($20,000-$2,000 paid through the Chapter 13 plan), and thus not taxable as income.      Let’s do some math here. Remember you in effect paid $10,250 to settle the debt on your own? If you filed Chapter 7, then you would have paid between $1,700-$2,000 to discharge the debt (any all your other debt), with no tax consequences. So you saved $8,250 to $8,550. If you filed a Chapter 13, and had a 10% plan, you would have saved $4,250 to $5,250, with no tax consequences (and all your other debt would have been taken care of also).      So, there is an advantage to filing bankruptcy over settling the debt on your own (or through a debt settlement company) and no tax consequences. You are not required by tax law to declare as income the amount discharged in bankruptcy, as opposed to reporting the cancelled debt as income on a 1099-C.      If you would like a free consultation, call your Detroit Bankruptcy Lawyer at (586) 439-4297 (Macomb County) or (248) 581-0598 (Oakland County). I have night and weekend appointments available and I have offices in Mt. Clemens, Troy, Southfield, Livonia, and Rochester. I will analyze your financial situation and determine if bankruptcy is an option for you and under which Chapter to file under. If bankruptcy is not an option, I will tell you and direct you to resources that can help. So don’t delay because you are afraid of a 1099-C.


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