Does Settling Your Credit Card for a Lower Balance Affect You When You File Income Taxes?

Debt settlement can free you from debts that are weighing you down.

Debt settlement can free you from debts that are weighing you down.

Settling credit card debt can be a helpful solution if you’ve got more debt that cash and have fallen behind on your payments, but it can be a mixed blessing. You may get some relief on your credit card payments, but under certain circumstances the Internal Revenue Service gets notified, so don’t get too happy too soon. Settling debt can definitely affect your tax bill, and not in a good way.

Reasons for Settling

If you’ve fallen several months behind on your credit card payments and can’t see how you’re going to get caught up, settling the debt may be a good option. Settling isn’t only for people teetering on the verge of bankruptcy; it can help anybody who has had some unexpected financial problems. You may find it necessary to settle if you’ve had a change in circumstances, such as the loss of a job, a major illness, divorce, the breakup of a partnership or another issue that significantly affects your income. Don’t expect that settling is going to help your credit score – it won’t.

How to Settle

If you find yourself needing to settle your credit card debt, contact the card issuer and speak to the collections department. Tell the representative that you want to discuss settling and ask to speak to someone who can help you, then offer a settlement proposal. Depending on the company, how late your payment is and your personal circumstances, it may accept a settlement for far less than you actually owe. This amount can be as little as 50 percent of your balance, and sometimes even less.

Tax Implications of Settling

When you settle a large amount of credit card debt and the company writes off $600 or more, it will send both you and the IRS a form 1099-Misc. The IRS treats the amount on the 1099 as income for the year. At the very least, you can expect to owe more taxes due to the additional income, and under certain circumstances you may end up being propelled into a new tax bracket that will hit you even harder at tax time. It’s a good idea to check with a tax professional before deciding to settle a large amount with a credit card company.

Other Options

If you’re thinking that maybe settling your credit card debt for a lesser amount isn’t quite as great as it seemed at first, check out what other options might be available to you. Talk to the creditor; many credit card companies will work with you to lower your interest rates, freeze late fees or reduce your monthly payments during a period of hardship. It’s likely that they will close your account, but if you’re having trouble paying, that may be the best thing for you.

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