Have you heard of the saying, “There ain’t no such thing as a free lunch”?. Well, in the case of bankruptcy debt relief, there is! If you file bankruptcy, your debt is eliminated. So, you have to pay tax on the debt you got rid of, because it was cancelled, right? WRONG!
Here, we are talking about two different ways of getting rid of debt. One you have to pay taxes on, and one you don’t. The first way to get rid of debt is to settle the debt. When a debt is with a collector, you can sometimes settle the debt for a percentage of the amount owed. So, say you owed $10,000.00 on an old credit card, and the collector agrees to take $5,000.00 to settle it. Then, at the end of the year, you’ll get a 1099-C Tax form for the “cancellation” of the debt. You’ll have to give this to your tax preparer, and, most likely, pay taxes on this, at you regular rate.
The other way to get rid of debt is if you file for bankruptcy relief. In the same situation, if you have a $10,000.00 balance on a credit card that is included in bankruptcy, and the bankruptcy is discharged (completed), you’ll have $10,000.00 eliminated. But, in this case, you will not have to pay any taxes. Sometimes, you may even get a 1099-C on that debt. But, regardless, because it was included in a bankruptcy, no taxes are owed!
There you go, a free lunch! Tax free debt elimination, courtesy of the US Bankruptcy Code.
If you have questions about debts and taxes, or anything in between, call and we can help you.
Daniel J. Winter
Offices in Chicago, Gurnee, Oak Lawn, and Skokie, Illinois.