Ohio consumers who have substantial delinquent credit card debt may receive settlement offers to take care of the past-due balances from time to time in the mail. Sometimes, people enter into settlement agreements with the credit card companies, often settling their owed debt for half or even less of the total balance.
While a settlement of credit card debt may seem like a terrific way to get out from under unmanageable obligations, most people do not realize that doing so may come with some pretty steep tax consequences. The IRS considers the amount of canceled debt in some cases to be taxable income, and so any amounts of $600 or more that are canceled as a result of a settlement are reported by the credit card companies to the IRS each year.
The consumers will then receive a 1099-C in the mail from the creditor as required by law. The 1099-C is a statement of miscellaneous income and it must be entered as such on the individual's income tax return. This can potentially lead to a significant tax liability from the IRS. There is no requirement that creditors inform debtors that settlements can result in tax liability, and many do not do so. Some consumers are thus caught unaware by the unexpected tax bills that come as a result.
Despite the taxes, settling credit card debt still makes sense for some people. For others, an alternative they may wish to consider is choosing bankruptcy instead. People may be unable to afford to pay offered settlements even if they are otherwise unconcerned about the tax liabilities. By filing bankruptcy, people are able to obtain debt relief. The IRS does not count debt that is discharged in bankruptcy as income for tax purposes, unlike the treatment for canceled debt through a negotiated settlement.
Source: CreditCards.com, "1099-C surprise: IRS tax follows canceled debt", Connie Prater, November 24, 2014