Consumers may owe tax on forgiven credit card debt

Debt may seem like a looming, inescapable problem. Mississippians have several options, however, to tackle their credit card debt. Many creditors are willing to work with individuals and their financial challenges to reach a solution that benefits both parties.

One solution available to individuals with credit card debt, who face constant creditor harassment, is approaching the creditor to negotiate. Many consumers in Mississippi as well as throughout the U.S. have successfully wiped out their credit card debt by reaching a settlement with their credit card company.

Typically, the entire debt is not erased. Instead, the creditor will forgive part of the debt, and leave a remaining balance that allows a consumer to make more manageable payments. For example, a creditor may forgive $5,000 if a consumer has $15,000 in credit card debt -- leaving the balance at only $10,000. Such a settlement can provide a consumer with a breath of fresh air, and kick start the consumer's ability to successfully overcome financial challenges.

There are important legal consequences from such settlements, however, that Mississippians may overlook. The law classifies the wiped out credit card debt amount as income. As a result, in some situations, a consumer must pay tax on the forgiven debt.

Specifically, the law requires those who forgive at least $600 to disclose the settlement to the Internal Revenue Service and potentially pay tax. Turning to the example of the $15,000 debt above, the consumer who had $5,000 forgiven would have to pay $750, if he or she is in the 15 percent tax bracket. This can be a substantial amount of money to pay -- especially if it is an unexpected expense.

Mississippians with credit card debt should appreciate that settlements can be a real option. However, they should be prepared for the consequences of their decision to negotiate to have their debt forgiven. They may face taxation, even though the debt has been erased.

Source: Ecreditdaily.com, "Non-Mortgage Forgiven Debt: Are Wiped Out Credit Card Loans Taxable?," March 16, 2013.

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