If you're in the process of settling a debt or thinking about approaching a creditor to begin debt settlement negotiations, it's important to remember that the IRS considers forgiven debt to be taxable income. What this means is that if you owe $10,000 on a credit card and settle with your creditor for $4,000, the difference of $6,000 will be reported to the IRS as earned and taxable income.
This may not be a huge deal if the forgiven debt is a small amount, but if you're negotiating a substantial debt settlement, then it's something you must factor into your negotiations with the creditor. Not every debt settlement, however, has to lead to a bigger tax bill. If you are currently in bankruptcy proceedings or considered insolvent (your liabilities exceed your assets), the IRS may waive this tax. Be sure to talk with your bankruptcy lawyer or accountant for more information specific to your financial situation.
