What Is the Charge-Off of a Credit Card Account?

A charge-off includes any amount of a customer's balance due on a credit card that the bank writes off as uncollectible. This may be the entire balance or, in the case of debt settlement, a portion of the balance. The bank may require the reduced balance to be paid in one lump sum or over several months. Once the lower balance is paid in full, the debt is considered closed by the lender.

Benefits

In cases where customers have gotten over their head in debt, a partial charge-off can reduce their credit card debt to a manageable amount. A monthly payment option can help the customer get back on track. Charge-offs for the full balance due mean an end to creditor calls.

Credit Considerations

Charge-offs can only be done on delinquent accounts--and delinquencies will drop credit scores. When the lender writes off part of the balance due, "the notation on your credit report that the account is settled (rather than paid in full) could further depress your credit score and look bad to future lenders," says Leslie McFadden at Bankrate. In addition, most banks will close the account--further harming credit scores.

Preserving Credit

When discussing a charge-off, ask the lender how to reduce negative impacts to your credit score. According to Equifax, late payments are one of the most common negative impacts to credit scores. Banks may honor a request to re-age the account--a process that wipes late payments off your record. Ask the bank to allow you to close the account, which does not harm credit scores.

Tax Impact

The Internal Revenue Service (IRS) requires the lender to report the amount charged off and send a tax form 1099-C to the customer in time to include that amount as income on the next year's taxes. In the case where $10,000 is owed to a lender, if a settlement is agreed upon for $4,000, then $6,000 is considered gross income by the IRS. For a 15 percent tax rate, the federal amount owed is $900. On a full charge off, the tax bill would be $1,500.

Potential Penalties

When the debt settlement requires an up-front payment in full, it can be tempting to withdraw funds from qualified retirement accounts. This will incur additional tax penalties. "It's an incredible hit," says Elizabeth Mance, founder of Accountability Services, a Seattle-based accounting firm serving small businesses. "If you're under 59-and-a-half, you have to pay taxes on that money. Then you get hit with a 10 percent penalty."