Credit Settlement Agreement

A credit settlement agreement is an agreement to resolve a debt. More commonly known as a debt settlement agreement, such an agreement allows you to pay off unsecured debts such as credit cards for less than the full amount owed. Settlement is a popular option for resolving excessive debt and is considered an alternative to bankruptcy.

Terms

Terms for settlement agreements vary. SmartMoney reports that credit card debt can be settled for 20 to 75 percent of the balance, with settlements of around half the balance most often available. Settlements can be paid in a lump sum or in installments, with the agreements usually possible only after you have fallen behind on your payments. Creditors sometimes suggest settlements through the mail or by telephone. Customers can also request a settlement.

Timeline

Banks, credit unions and other creditors generally will assign your account to an internal collections team after you fall two or three payments behind. Collection efforts escalate with increased phone calls and letters as you fall further behind. Accounts are usually closed and listed as charged off after becoming six months past due. A charge-off is an internal accounting term that does not relieve you of responsibility for paying the debt. Settlements are usually available before the charge-off date, but the exact timing is up to the creditor. Creditors can offer settlements at any time or not at all.

Tax Implications

Settlement can lead to fantastic savings on a credit account, but some of the advantage can be lost at tax time. The Internal Revenue Service may treat the amount you saved as income, resulting in a higher tax bill. For example, settling a $13,000 credit card debt for $5,000 would increase your taxable income for the year by $8,000. People saving more than $600 through a settlement receive IRS Form 1099-C tax notices from creditors. You must report the amount listed on the form on your tax return.

Insolvency

Some people avoid tax penalty by requesting a waiver. The IRS allows exceptions for people who who were financially insolvent before the settlement. Insolvency means your debts were greater than your assets. For example, say your debts totaled $55,000 and your assets $45,000 at the time of your settlement. In this case the IRS would consider you to be insolvent by $10,000 -- the difference between your debts and assets. As a result, a settlement resulting in a savings of less than $10,000 would not have to be reported to the IRS.

Timing

Settling early in the year gives you more time to prepare for tax implications than settling later in the year. Settling an account in December means you possibly are incurring additional taxable income in the last month of the year, with payment due just four months later in April. Waiting another month to settle in January would give you more than a year to prepare for the tax bill.