Tax Debt Settlement

There are various different ways in which a government collects taxes from its people. Income tax, sales tax, and other duties such as excise and customs. The most prominent among all the taxes is the income tax. Debt consolidation, settlement and debt forgiveness, tend to have a genuine effect on the amount of income of a person that falls under the tax bracket. The Internal Revenue Service (IRS) maintains a simple logic about the income that is subject to any tax. Debt relief, debt settlement, and debt forgiveness are basically taxed due to the following logic. A debt basically arises when a person avails a loan, uses a credit card, or uses any goods or service, without actually undertaking the burden of paying the consideration. It basically means that the goods or service is used and the money is not paid. Under normal circumstances, the person has to repay the total amount that has been used. In some cases, the concept of debt settlement comes into the picture. The following paragraphs will solve your queries regarding income tax, debt settlement, and loan negotiations.

What is Debt Settlement?

The first question that you are bound to ask is what is the connection between debt settlement and tax? Debt negotiation or debt settlement or debt arbitration is a process that is undertaken by the borrower or representatives of the borrower.

When a borrower is unable to make installments of a particular debt that he has already availed , then he or his representatives can undertake a procedure that is known as debt settlement. In simple terms, debt settlement is a process of negotiation, wherein the creditor and debtor agrees on a particular reduction in the total amount of debt. There are various different parameters that are used to decide the amount of debt. This process can be initiated by either parties with the help of debt management companies, debt settlement attorneys, or even on their own.

Why is Debt Settlement Taxed?

Coming back to the topic of settlement and tax, debt reduction of any kind of means that the person concerned, that is the borrower is not supposed to make partial payment of some goods or services that have been used by him. It means that it is an indirect income that comes under the bracket of average income tax. Settlement of debt is thus taxable.

The IRS has however decided to address this problem of taxation of tax relief. Settlement amounts and the financial condition of the person are taken into consideration, in accordance with a scheme that is known as Offer in Compromise. Another similar enactment is the Mortgage Forgiveness Debt Relief Act, that deals with relief or forgiveness of mortgage and tax. Settlement of debt is however only governed by the Offer in Compromise. The OIC is basically a process with the help of which the tax payers can negotiate the taxable income and tax liability for that accounting year's income tax. Debt consolidation may also have similar conditions from the viewpoint of IRS. One can avail the IRS Publication Form 982, in order to file for the OIC that provides tax relief settlement.

he IRS usually taxes any settlement or debt forgiveness that exceeds $600. Another debate that might erupt is, will the interest that is being forgiven come under the bracket of income tax. Debt settlement concerned about the total amount that is payable, that includes the interest too. However, interest is a charge levied by the lender, hence, theoretically it is not taxable. But in some cases ,it might come under the tax bracket. Tax laws are extremely complex and you will have to check many similar things when you file your returns.