Make a debt settlement in 2022? Prepare for that unwanted surprise

Image source: Getty Images

Being in debt can be extremely stressful. Between calls from creditors urging you to pay and constantly knowing that you owe a lot of money, debt could have a very negative impact not only on your finances, but also on your quality of life.

If your debt has reached a point where it has become unmanageable, it may be time to consider making a debt settlement. With a debt settlement, a creditor – whether it is a doctor’s office, a credit card company or another lender – agrees to accept less than what you owe. If you owe $2,000 on a loan, a lender might accept a payment of $1,200 and write off the rest. Once you pay that $1,200, you won’t owe that lender any more money.

If you’re wondering why a particular creditor might agree to a debt settlement, it’s simple. This way they get some amount of money rather than running the risk of having to keep chasing you for not potentially getting any.

You can enter into a debt settlement agreement on your own or with the help of a debt settlement company or a lawyer. But going this route has consequences.

Every time you make a debt settlement, it shows up on your credit report. And that can then serve as a major red flag for lenders.

Imagine you want to take out a Personal loan and have a recent debt settlement on your file. A lender might be hesitant to let you borrow money after seeing that your last lender hasn’t been repaid in full.

But while a debt settlement can put a black mark on your credit report and lower your credit scoreyou could face another costly repercussion.

A new tax obligation

When you make a debt settlement, the amount of your debt that is written off is usually reported to the IRS. And it’s generally considered taxable income. If you make a debt settlement this year, you could end up owing money to the IRS next year when you file your 2022 tax return.

Let’s say you owe a lender $2,000 and settle your debt for $1,200. At this point, you may owe taxes on the $800 that your lender writes off. You’ll need to report that $800 as income on your tax return, and it may result in a higher tax bill for you.

This does not mean that you will automatically owe money to the IRS because of a settled debt. Let’s say your write-off of $800 results in a tax bill of $200. If the IRS owes you $500 as a refund, you won’t have to write a check. Instead, you’ll just get a smaller refund.

The point, however, is that debt amounts written off are generally considered taxable income. And that’s something you’ll have to prepare for.

What if you can’t pay the IRS?

You may come across a situation where you owe the IRS money due to a debt settlement. If that’s the case and you can’t fully cover that tax debt, you can ask the IRS to put you on an installment plan where you pay it off over time.

But don’t just get rid of your tax liability. If the IRS doesn’t get paid, it could come after your paycheck, and that’s not a scenario you want.

Earn up to 5% cashback and waive interest until 2023

Our in-house credit card expert loves this best credit card choicewhich includes a 0% introductory APR through 2023 that can help you avoid interest charges on new purchases or pay off debt faster using simple balance transfer strategies. Plus, this choice offers an insane cashback rate of up to 5% with no annual fee. In fact, this card is so good that our credit card expert even uses it personally. Click here to read our full review for free and apply in just 2 minutes.

Read our free review

We are firm believers in the Golden Rule, which is why editorial opinions are our own and have not been previously reviewed, approved or endorsed by the advertisers included. The Ascent does not cover all offers on the market. The editorial content of The Ascent is separate from the editorial content of The Motley Fool and is created by a different team of analysts. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Source link

John A. Bogar