[JessicaLevin27]

My question involves collection proceedings in the State of California.

Occasionally I get offers from CC companies to settle debt for less than the full amount.

I have heard that if a settlement is reached and I make a lump sum payment, the amount "forgiven" is taxable and the company issues me (and the IRS) a 1099? Any advice about that? I also read somewhere that if you can prove you could not have paid off the amount that was "forgiven" then the IRS will not enforce the tax.

In your experience, and I know this varies from company to company, what percentage will a credit collection company accept?

I have one arbitration award against me, the original debt in 2003 was $32K, it went up with interest and the arbitration award in 2006/2007 (can't remember exact date or amount, have to find the letter, but I have a letter from March of 2006 saying I owed $38K - that could have been before the arbitration award however)...got a letter today saying the balance was $61K! I can't believe that even with interest and fees, it could have gone up that much in two years. But that's a separate issue. I'm writing to the debt collector to have them verify the debt.

The original card issuer was MBNA. The letter I got today says "...your account has been plaed with NCC for collection by Genesis Financial Solutions." I assume Genesis has purchased the debt. NCC is "a division of Commonwealth Financial Systems, Inc."

Also, is there a limit on the interest that can be charged on debts that have been placed in collection, or have gone to arbitration?

[divemedic]

What a CC will accept varies from bank to bank. Some will settle for half.

Generally, if a debt for which you are personally liable is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. If a financial entity cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C. Unless you meet one of the exceptions or exclusions discussed later, the canceled debt shown on Form 1099-C, box 2, is ordinary income from the cancellation of debt and must be reported on the appropriate form shown above.

My own personal experience is that the IRS is a stickler about granting the exceptions. The most common one is insolvency, and in my experience you have to be bankrupt for that one to apply. YMMV.

[JessicaLevin27]

What a CC will accept varies from bank to bank. Some will settle for half.

My own personal experience is that the IRS is a stickler about granting the exceptions. The most common one is insolvency, and in my experience you have to be bankrupt for that one to apply. YMMV.

Actually I researched this after I posted that question yesterday. While bankruptcy is indeed one way to avoid the tax, it appears that anybody with negative net worth can avoid paying tax on at least some of the gift, and possibly all of it. The IRS has a publication about this:

http://www.irs.gov/pub/irs-pdf/f982.pdf

There's a simple test for eligibility, called the "insolvency" test. The way it works is that on the day before you send payment to the creditor for the lump sum payment that discharges the debt, you:

(1) calculate the fair market value of all of your assets, even those which could never be seized to settle debts (personal property, cars, retirement plans, home equity);

(2) calculate your total liabilities (debts);

(3) subtract your liabilities from your assets.

If the result is negative, you are insolvent in that amount. Let's say you're insolvent in the amount of X dollars. If the amount forgiven is less than X, YOU DO NOT OWE TAX ON IT - because even if you had sold everything you owned at fair market value, and used it to pay off your debts, you would not have been able to pay off the amount forgiven. If the amount forgiven is more than X, you still don't have to pay tax on the first X dollars of the amount. Pretty sweet.

Of course, this doesn't apply to people with lots of assets (such as a well-funded retirement plan, or home equity).

But if you do qualify, the form is very simple to fill out: Check box 1(b), enter an amount on line 2, and enter an amount on line 10. This gets attached to the tax return, and NO income is reported on the tax return from the 1099-C. I believe you also have to attach a simple statement of assets and liabilities, and it has to be FMA (fair market value) as of the day before you made the lump sum payment.