Debt Consolidation/Relief Part 2 of 2

In the first part of this series, we covered the misleading things that businesses advertise on television, radio and elsewhere for “debt consolidation” or “debt settlement” services.

If you decide to enter into an agreement with a creditor, or want to fix a bad credit score keep these five things in mind.

How to proceed with the agreement

1. Get the settlement terms, in writing, from the creditor prior to making any payments.
2. Do not give the creditor a check by phone, a bank draft authorization, or other unfettered access to your bank account. The safest way to make settlement payments is through bank checks (cashier’s checks, etc.) sent through the mail.

You’ll owe the IRS

3. A credit card company that has settled for less than full value is legally obligated to issue an IRS form 1099 to you, reflecting the amount of the balance that was written off or “forgiven.” This gives rise to debt forgiveness income, which has tax consequences. For example, if you settle a $20,000.00 credit card balance for $10,000.00, then the credit card company will send you and the IRS a form 1099 showing $10,000.00 in debt forgiveness income, and you may be taxed on this forgiven $10,000.00 as if it were ordinary income. You should discuss with a tax professional what the tax implications of any debt settlement would be, and factor that in; these taxes are not immediately dischargeable in a bankruptcy and must be dealt with. In contrast to debt that is settled, debt that is discharged in a bankruptcy is not forgiven — it is instead discharged or cancelled — and there is no resulting debt forgiveness income or other tax consequence as a result of the discharge.

Your credit score

4. Once a credit card company has received the total settlement amount, it should report to the credit bureaus that “the debt was settled for less than full value” or some similar language that may vary from creditor to creditor. This information negatively affects your ability to obtain credit, but is generally less damaging to your credit rating than unresolved defaults, judgments, or a bankruptcy.
5. Beware of any offer of “credit repair.” The only information that can be removed from your credit report is inaccurate information. If there is accurate but negative information on your credit report, then the only repair is the passage of time. Negative information stays on a credit report for a maximum of seven to ten years before dropping off. Money paid to eliminate accurate but negative information is always a waste of money.

If you have any questions about whether, in your particular circumstances, debt consolidation makes sense, contact qualified legal counsel or one of the services recommended in Part 1 of this series.