The Bankruptcy Alphabet: “D” is for “Debt Settlement”

April 30, 2012

Potential clients often ask me about the possibility of trying to settle their debts, as opposed to filing for bankruptcy. For some, this may be an option to consider. For most people the cost of debt settlement outweighs the benefits.

There are many companies that advertise an ability to settle your debts for pennies-on-the-dollar. If you decide to investigate this route, do your homework. Understand how these companies work and how you will be charged. Do your internet research to try to uncover unhappy customers. Those are easier to find than you might think.

The majority of these companies charge a percentage (usually 15%) of the debt they will be addressing for you. So if you have $50,000 in credit card debt, their fee can easily be $7,500.00. There are generally monthly administrative or processing fees in addition to the percentage fee.

Once you agree to participate, these companies will set you up on a payment plan. What most people don’t understand is that the initial payments are applied to the company’s fees, not to your debts. Meanwhile your creditors are receiving nothing and the interest on your debts is continuing to mount.

Once you accumulate sufficient funds on deposit with the debt settlement company to settle one of your debts, the company will approach one of your creditors about settling the debt for a percentage of what you actually owe. If an agreement is reached with that creditor, the money you have on deposit with the debt settlement company will be used to settle that debt. Meanwhile, the rest of your creditors are becoming restless, having received nothing in many months.

Once a settlement has been reached with one creditor, the debt settlement company will do nothing until you have accumulated enough money on deposit with them so that they can settle another account for you. Quite often one of your creditors will be come too impatient to wait for their money any longer. They will hire a local attorney and will sue you to collect. This is what drives many potential bankruptcy clients into my office.

Clients who have worked with debt settlement companies are often shocked to learn that after months (or years) of payments, very little of their money has been applied to settle their debts. These clients are even more shocked to learn that the debt settlement company couldn’t help them when they did get sued.

The final surprise generally comes at tax time. For many people, they will have to pay tax on the amount of forgiven debt, as if it were income. Who wants to pay tax on income they didn’t receive????

Before you consider settling your debts, consult with an experienced bankruptcy attorney. Most offer free consultations. You will then be in a better position to weigh all of your options.

The Bankruptcy Alphabet: “C” is for “Cancellation of Debt Income”

April 14, 2012

Individuals in financial trouble are often surprised at tax time when they receive a 1099-C statement from a creditor. Many times these statements come from credit card companies where individuals have made a settlement of the debt for less than the full account balance. In other instances the creditor has simply charged off a defaulted debt.

The amount of unpaid debt was canceled by the creditor. This canceled debt is often known as “cancellation of debt” (COD) income. The creditor will then report this canceled debt to the Internal Revenue Service, and the individual will then be taxed on that canceled debt as if it were income.

If you receive a 1099-C, don’t panic. All is not lost. If you meet certain exceptions you will not have to pay the tax on this “income”. One of those exceptions is if the debt was discharged in a bankruptcy filing. If you meet one of the exceptions, Form 982 must be filed with your tax return so that you will not have to pay tax on the canceled debt.

If your tax preparer doesn’t know about Form 982, find another tax preparer.