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Debt Settlement Surprise - Beware of Hidden Taxes

March 7, 2021

Lots of people pay lots of money to debt settlement companies. Some people are happy with the services provided by their debt settlement company, while others are unhappy, especially after they do all the math and find out how much of their money has gone to high fees charged by their debt settlement company. Others are even more unhappy when they wind up getting sued by some bill collectors that they thought were included in their debt settlement program.

In this blog, I am not going to go into the many pros and cons of hiring a debt settlement company. Instead I'm going to talk about a potential surprise you may receive in the mail after your claim has been settled by the debt settlement company. Let me give you a simple example:

  1. You are behind in your credit card bills. You have 4 credit cards, and you owe $5000 on each card, for total debt of $20,000

  2. You have learned that you could file a chapter 7 bankruptcy and have all of that debt legally forgiven in about 4 months, while keeping whatever assets and retirement funds you own.

  3. But instead of filing for bankruptcy and getting all of your bills wiped out, you have decided to hire Stupid Settlement Company to see what they can do to help you out.

  4. You sign up with Stupid because they have sort of convinced you that they can settle your debts for about 35% to 40% of what you owe, but they have not given you any written guarantees.

  5. They will charge your bank account $400 a month, and they will charge you a fee for their services, but you don't quite understand how much that fee is.

  6. Stupid charges you account for 3 years, for a total of $14,400. After 3 years, they let you know that they have settled each of your 4 bills, but not for 35% or 40%. They say the best they could do was 50% for each bill collector.

  7. So since you owed each bill collector $5000, by settling for 50%, each bill collector gets paid $2500, and the total paid to the bill collectors is $10,000.

  8. But you paid a total of $14,400 to Stupid, so what happens with the remaining $4400? Oh, conveniently that is the fee that is being charged by Stupid.

  9. So you had $20,000 in debts 3 years ago. You paid $10,000 to the bill collectors and $4400 to Stupid. You do the math and you figure you saved $5600, and that doesn't sound too bad, does it? Some people might say that's terrific, and other people might say they are not happy because they thought they would be paying just 35% of the debt. They also might think that the fee charged by Stupid was way too high. Other people might be wishing that they had filed for a chapter 7 bankruptcy 3 years ago, and maybe paid $1500 to $2000 to a bankruptcy lawyer and gotten out of all that debt without having paid the bill collectors anything at all. They could have kept all of their property and wiped out their bills in about 4 months, instead of having struggled here for 3 plus years.

  10. Now get ready for your big surprise, and its not exactly a pleasant surprise. After having paid Stupid their fee, you saved $5600 on that total debt of $20,000. But guess what? Each of those credit card companies has sent you a tax form that says that you saved $2500 on their bill, and they are reporting that to the IRS because the IRS is going to count that debt forgiveness as income to you. So here is the bottom line. It looks like you are going to have to pay the IRS taxes on the $10,000 total that you saved. Now how much is that going to cost you? Maybe $2000? Maybe more? It depends on your tax bracket, and you should also be made aware that you might possibly be able to get out of paying the IRS anything if you were in fact insolvent at the time the debts were settled. There is a special form you can file, and its called form 982, If you qualify to file form 982, you might get out of payinig all of those taxes, and the best thing here is to talk to your accountant or tax preparer and see what they can possibly do to get you out of that potential tax liability.

Let's hope you don't have to pay those taxes. But let's also consider that if you have to pay a 20% tax rate on savings of $10,000, that amounts to another $2000.that all this debt settlement is costing you. So now add $2000 to $14,400 and you've spent $16,400 over 3 years on this $20,000 worth of debts. Was it all worth it?

Would you have had a lot less stress, a lot less aggravation, and a lot more money and peace of mind.if you had filed for bankruptcy 3 years ago?

The answer to that question is for you to decide.

Seymour Wasserstrum - Your Underdog Advocate