tax on debtors


Z

z

We have a friend who ran up over $150,000 on credit cards while he was
unemployed. He has now started a business and is saying he's doing well and
thinks he'll be able to pay off the debt in a few years.

Is there any provision in the tax codes for those who are heavily in debt?

Thanks for any info.
 
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P

Phil Marti

z said:
We have a friend who ran up over $150,000 on credit cards while he was
unemployed. He has now started a business and is saying he's doing well
and thinks he'll be able to pay off the debt in a few years.

Is there any provision in the tax codes for those who are heavily in debt?
The only thing I can think of is that if he works out a settlement with the
credit card companies for less than he owes he could have taxable income
equal to the forgiven debt. See IRS Publication 525.

Some other thoughts.

Absent unusual circumstances, your friend managed to run up $150K in debt
while unemployed because he couldn't live within his means before he was
unemployed, and it just got worse. Unless he's reformed, he needs a severe
budget and a big reduction in lifestyle.

If he's self-employed, with or without employees, and fixated on reducing
debt he's at risk for shifting the debt from credit cards to the IRS. He
has to have the discipline to make estimated tax payments (and payroll taxes
if applicable) as they come due. That means socking money away as he earns
it and keeping it someplace where he can find it when the tax bill comes
due.
 
P

Paul Thomas, CPA

z said:
We have a friend who ran up over $150,000 on credit cards while he was
unemployed. He has now started a business and is saying he's doing well
and thinks he'll be able to pay off the debt in a few years.

Is there any provision in the tax codes for those who are heavily in debt?



Not that impact someone who is paying off their debt.
 
G

Gil Faver

The only thing I can think of is that if he works out a settlement with
the credit card companies for less than he owes he could have taxable
income equal to the forgiven debt. See IRS Publication 525.

I'm curious: does this apply to interest and fees, as well as the underlying
charges?
 
M

Mark Bole

Gil said:
I'm curious: does this apply to interest and fees, as well as the underlying
charges?

If they were added to the principal and became part of the canceled
debt, yes.

However, if the debt would have been deductible had it been paid, then
it is excluded from income when canceled. This is most likely not the
case with credit cards.

-Mark Bole
 
B

Bill

(e-mail address removed) (Mark Bole) posted:
Gil Faver wrote:
If they were added to the principal and
became part of the canceled debt, yes.
However, if the debt would have been
deductible had it been paid, then it is excluded
from income when canceled. This is most
likely not the case with credit cards.
For some reason, this prompted me to wonder whether the ultimate weapon
for a vindictive Credit Card company, might possibly lie in punishing
those who declare bankrupcy, by responding with a "forgiveness" of debt,
and the ensuing 1099 report of this "cancellation." If so, I wonder
what effect that would have on the TP involved. Nothing good, I'm sure.

I'll confess this thought occurred to me, because I once tried to bail
out a relative by negotiating a discounted settlement of CC debt, with
my pledge to provide cash to directly settle the reduced balance (which
would simply erase all interest and late charges -- which amounted to
almost half of outstanding balance). Several issuers were totally
agreeable, but they warned me if one particular issuer were involved,
they would probably insist on the bankrupcy proceedings.

Turned out they were right. That one company blew the deal, and ended
up costing all of the debtors I felt what was a most reasonable
settlement. I won't name them, but it surely dumbfounded me, that they
would "bite off their nose to spite their face." (And no, they didn't
have the largest piece of the pie, either!)

So that's the reason the thought of a vindictive CC company popped into
my mind. (BITD when my experience took place, there was no
1099-C[ancellation of debt], AFAIK.)

Bill
 
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P

Phil Marti

Bill said:
For some reason, this prompted me to wonder whether the ultimate weapon
for a vindictive Credit Card company, might possibly lie in punishing
those who declare bankrupcy, by responding with a "forgiveness" of debt,
and the ensuing 1099 report of this "cancellation." If so, I wonder
what effect that would have on the TP involved. Nothing good, I'm sure.
No effect to something pretty good, actually. Since the debt was discharged
(I assume) by the bankruptcy there's no cancellation of debt income. Plus,
the creditor issued a false 1099-C, which creates a Federal cause of action
for the debtor.
 
S

Stuart Bronstein

For some reason, this prompted me to wonder whether the ultimate
weapon for a vindictive Credit Card company, might possibly lie in
punishing those who declare bankrupcy, by responding with a
"forgiveness" of debt, and the ensuing 1099 report of this
"cancellation." If so, I wonder what effect that would have on
the TP involved. Nothing good, I'm sure.
Cancellation of debt is not considered taxable income if the person
is insolvent at the time. If bankruptcy is filed issuance of a 1099
should not result in taxable income, though an explanation may have
to be made to the IRS.
I'll confess this thought occurred to me, because I once tried to
bail out a relative by negotiating a discounted settlement of CC
debt, with my pledge to provide cash to directly settle the
reduced balance (which would simply erase all interest and late
charges -- which amounted to almost half of outstanding balance).
Several issuers were totally agreeable, but they warned me if one
particular issuer were involved, they would probably insist on the
bankrupcy proceedings.

Turned out they were right. That one company blew the deal, and
ended up costing all of the debtors I felt what was a most
reasonable settlement. I won't name them, but it surely
dumbfounded me, that they would "bite off their nose to spite
their face." (And no, they didn't have the largest piece of the
pie, either!)
Some think that they will come out ahead over all by taking a stand
like that, because they think most threats to file bankruptcy are
hollow.

Stu
 
G

Gil Faver

Stuart Bronstein said:
Cancellation of debt is not considered taxable income if the person
is insolvent at the time.
just insolvent at that time, or you go through bankruptcy? A person can
overcome insolvency, even without bankruptcy.



If bankruptcy is filed issuance of a 1099
 
S

Stuart Bronstein

Gil Faver said:
just insolvent at that time, or you go through bankruptcy? A
person can overcome insolvency, even without bankruptcy.
Without looking it up, my understanding is that only insolvency is
required. Bankruptcy is evidence of insolvency, but is not required to
avoid tax on cancellation of debt.

Stu
 
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A

Arthur Kamlet

Without looking it up, my understanding is that only insolvency is
required. Bankruptcy is evidence of insolvency, but is not required to
avoid tax on cancellation of debt.
Has anyone had a chance to read Pub 4681? It's new, and covers
just about everything you wanted to know about cancelation of
debt.

And is actually pretty readable.
 
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