How to Account for Debt Forgiveness

Forgiven debt is when a credit card company allows you to pay less that your outstanding balance as a settlement. The portion of debt not paid is called forgiven debt. In other situations a creditor will determine that they cannot collect a balance and they will consider it forgiven debt. When you have debt forgiven, there are several things you have to consider and account for. Some of these things can affect your credit and other can create another type of liability. Before you have debt forgiven determine if it will benefit you. See if the pros out weigh the cons.

Instructions

1

Make a list of all the things that are affected when you have debt forgiven. Forgiven debt takes a strain off your budget. When you don't have to pay debt, it can take pressure off making payments to a particular creditor on a monthly basis. Once you have a list of all the things impacted by forgiven debt, see how they affect your finances or your credit history. Review each item individually to see if it will be worth the effort to have forgiven debt.

2

Determine how your credit is affected. According to creditcards.com a credit score of 780 can be reduced anywhere from 105 to 125 points due to a debt settlement. This is a tremendous hit on your credit score. When your score is lowered credit card companies will charge you higher rates of interest for their products. A mortgage company will also charge higher interest rates. This information will remain on your credit file for seven years.

3

Review other aspects of forgiven debt. When debt is forgiven, you may have to report it as taxable income on Line 21 of your 1040. The creditor will send you a 1099-C debt cancellation form. You should seek the advice of your tax professional when this form is received. There could be some exceptions to this rule. If you have a debt in the amount of $5,000 and you settle for $3,000 the forgiven debt of $2,000 may have to be reported as taxable income. This rule is in effect if the forgiven debt is $600 or greater.

4

Compare all of the forgiven debt changes and see if it will be cost effective for you. Speak to your accountant and tax person and get their perspective on the different changes. See if it will be worth your while to pursue a strategy that leads to forgiven debt.