Columbia, Maryland (PressExposure) April 16, 2009 -- Executives at Debt Shield, a Maryland-based debt settlement company, are reminding taxpayers that saving money through cancelled debt may have minor tax consequences.
Fully or partially cancelled or "forgiven" debts are sometimes considered taxable income by the IRS.
"Taxpayers who saved more than $600 with a debt settlement may be required to pay taxes on that amount," explained Debt Shield CEO Phil Fewster."However, some debt settlement clients are not required to pay taxes on canceled debt."
The IRS provides an exception for people who were insolvent at the time of the settlement. Being insolvent means that the amount of debt was greater than the fair market value of one's assets at the time of settlement, which is the case for many debt settlement clients.
"Even if you do have to pay taxes on cancelled debt, remember you are only paying because you saved more than $600," said Fewster.
Some critics of debt settlement try to use this provision as a reason not to pursue this debt relief option, but when debt settlement clients do pay taxes on canceled debt, the additional tax is small compared to the size of the debt - especially considering the 39 percent interest credit card companies charge some struggling consumers.
Financial institutions that forgive $600 or more of a debt's principal balance must send the taxpayer and the IRS a Form 1099-C. Taxpayers are typically not required to report debts canceled through a bankruptcy case under the U.S. Bankruptcy Code.
Debt settlement clients can learn more about the insolvency exception through the IRS' Publication 908 section on "Debt Cancellation." Debt Shield executives encourage debt settlement clients to discuss this provision with professional tax preparers before filing.