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What Happens When I Settle a Debt?

One of the things that perplexes people is what happens when a debt is settled. For those who don’t know, a debt settlement is any amount that is negotiated between you (or on your behalf) and your creditor that is less than the amount owed. Once this negotiated amount is paid, the debt is considered cleared and settled.

When this happens there is typically a tax consequence that follows. Let’s take a look at an example of what happens. Allen has a credit card balance of $45,000.00. Allen realizes that he is swamped in debt and negotiates with the credit card company to pay them $10,000.00 to settle the account. The credit card company agrees to take the $10,000.00 and clear the debt.

At the end of the year, Allen should receive a Form 1099-C which will show an amount of $35,000.00 in “Box 2” (amount of debt discharged). Under most circumstances, Allen will add the $35,000.00 to his tax return as income. There may be some insolvency or bankruptcy related issues that can reduce this amount so you should speak with your tax advisor.

The next question is, “Does settling a debt do harm to your credit score”. The short answer is “no” but that “no” is loaded. More than likely if you settle a debt, you have had trouble paying the debt in a timely fashion or you’ve had a difficult time reducing the debt utilization number. In either case, your credit score has probably taken a beating, so the settlement didn’t cause the damage, but the debt itself  caused the damage.

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About Frederick Towles

Frederick Towles is an entrepreneur, author and professional coach on personal finance, recognizing, seizing and leveraging opportunities of all kinds. Frederick founded The Towles Group Inc. to address issues that relate to small businesses and individuals – accounting, taxation, asset protection, financial compliance, wealth creation, debt management and business management. He also founded Unlimited Expectations Inc. which provides tools for individuals to assist them in the areas of opportunity recognition, leadership and personal finance. Through the tools and services offered by these companies people are positioned to operate their lives and their businesses at optimal capacity.

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