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If you previously racked up a lot of debt, and are considering settling the balance of that debt (or recently settled a balance), it is important to know how that will affect your taxes.
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There is something called “Cancellation of Debt Income” that requires you to pay taxes on any debt that is forgiven.
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This means that if you charged up $30,000 of credit card debt, then worked with the credit card company to only need to pay $20,000 back, you will owe income tax on that $10,000 forgiven balance.
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Why is this the case? Think of it this way: Essentially, by spending $10,000 you received the BENEFIT of that $10k (in the form of clothing, food, whatever you spent it on) and now no longer are required to pay it back. The IRS sees that as income to you, and so you must pay taxes.
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There are some provisions that allow you to exclude the cancellation of debt income from your taxes, so if you have this in your income you will want to work with a professional.
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But bottom line, it’s important to be aware that the settled money doesn’t just magically disappear; Uncle Sam will come knocking for his share when that debt is forgiven.
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Tag someone who you know needs to see this important message!
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