Can Debt Relief Affect Your Taxes?

Recent statistics from The Urban Institute indicate that one in every three Americans has debt. If you have owed a debt before, you probably understand the stress that emerges after failing to clear the loan on time. 

Working with a debt relief company is the easiest way to clear your debts at a lower price. But can debt relief affect your taxes?

Anytime you borrow money formally, you’re legally required to repay it in fixed amounts for a certain period. Relief of debt options such as debt settlement or forgiveness will help you pay for these debts and overcome serious financial challenges whenever you fail to pay on time. 

A debt settlement often occurs after an agreement between a debt relief company such as FreedomDebtRelief.com and your creditor is formed. A good agreement should entail regulations that require you to pay a percentage of the loan amount you originally had. 

When you have a significant portion of debt forgiven, the IRS often imposes a tax on the difference between what you owed your creditor and what you paid. The IRS will treat this debt balance the same way it does for the money you receive on your paycheck as income, usually taxable by law. 

Most Forgiven Debts are Taxable

Generally, whenever debt income is revoked due to cancellation, forgiveness, or relief of debt, the amount of the canceled debt is taxable, and you will need to report forgiven debt and the year of the cancellation while filing your tax returns. 

After a successful debt cancellation process, your creditor issues you a Form 1099-C, which indicates the total amount of debt forgiven and the date it occurred. This settled amount is considered the taxable income, and it’s subject to taxation. 

However, there are some situations where forgiven debt can’t be taxed. Read on to know some of these incidents.

Non-taxable Canceled Debts

On some occasions, your forgiven or eliminated debts will not be part of your taxable income. The IRS considers these occurrences exceptions. Some kinds of debts, which the IRS refers to as exclusions, could be lowered or minimized but not fully canceled. 

Here are the debts that the IRS considers exceptions, and the loans should not be taxed.

Exceptions

  • Some education loans like those of doctors and nurses working in rural or low-income areas.
  • Gifts, inheritances, devises, and bequests.
  • Deductible debts.
  • A price that’s reduced after you purchase a property.
  • Student loans of dead students or those with total disability. 

Exclusions

There are taxable debts that can be lowered or minimized. They need to be classified as exclusion when filing Form 982. These debts include:

  • Debt discharge of insolvent taxpayer.
  • Relief of debt through bankruptcy
  • Discharge of qualified farm indebtedness.
  • Relief of debt of qualified real property business.

As you navigate through the exceptions and exclusions, it is advisable to seek the services of a certified debt relief company with vast experience in debt settlement. This will help you know your options and avoid facing legal charges relating to tax fraud.

How Much Do You Have To Pay?

After the relief of debt, the amount you should pay is calculated the same way your income would be taxed. The normal tax rate in 2021 falls between 10 and 37 percent, depending on your taxable income. The US tax rate is progressive, implying that the tax rate will rise as the taxable base increases.

It’s a legal requirement to report all taxable income you receive, including the amount of your debt of relief. Failure to do this may result in fines, and you’ll still have to pay all the taxes you owe the government. 

Conclusion

So, can debt relief affect your taxes? Relief of debt brings you peace and certainty after realizing you don’t have to deal with debt collectors anymore. However, you will still need to pay taxes on the difference between what you initially owed your creditor and the amount you paid after the debt relief procedure.