Factors for Credit Card Debt Forgiveness

Large credit card debts can take years to pay off, and if the amount owed becomes overwhelming, bankruptcy may be an attractive option. But before taking such a serious step, many credit card users and credit card issuers try to work out a debt forgiveness agreement. The credit card company agrees to settle the account for a percentage of the balance, and the card user usually must close her accounts. While debt forgiveness can give you the financial fresh start you need without going through bankruptcy, the process can damage your credit and increase your tax liability.

Credit Card Settlements

If you are having difficulty making the minimum payments on your credit card balance, you may be able to get the card issuer to forgive part of your balance. In fact, some credit card companies may approach you about forgiving some of your debt, as they stand to make more money from a settlement than if they have to write off your account or you file for bankruptcy. While each credit card company sets its own rules for settling debts, your card company will take your credit history, income and current repayment status into account when making a settlement offer.

Charged-Off Accounts

If your credit card account goes unpaid for six months, the card issuer writes off the account as a bad debt for accounting purposes. This process, also called a charge-off, doesn't eliminate your responsibility to pay the debt, but usually means that the credit card company will sell the debt to a collection agency. Collection agencies that purchase debts normally pay pennies on the dollar for charged-off accounts. Because they invest so little in the debt, they are usually even more agreeable than credit card companies about settling for less than the amount owed. However, a charged-off account that goes to a collection agency will leave a serious stain on your credit report. If your goal is to preserve your credit, try to negotiate with the credit card company before letting your card get charged off.

Tax and Credit Consequences

There are some downsides to credit card debt forgiveness. The first is tax-related: The IRS treats forgiven debt as taxable income. If a card issuer charges off or settles a debt of more than $600, it will send you a 1099-C form with the amount of the forgiven or charged-off debt. You'll have to report this forgiven debt as income on your tax return. The second problem with debt forgiveness is that a creditor may report the account as "settled for less than the amount owed," which can damage your credit score.

While there isn't much you can do about IRS regulations, you can negotiate with a creditor to prevent the fact that you settled your debt from appearing your credit report. Before agreeing to settle a debt, ask your creditor to report the account as "paid in full." Be sure to get this agreement in writing before sending the company any money.