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  1. #1
    Join Date
    Jul 2008
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    853

    Default Re: Settling Debt for Less Than Full Amount

    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.

  2. #2

    Default Re: Settling Debt for Less Than Full Amount

    Quote Quoting divemedic
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    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.

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