17 May Debt Management Plans & IRS Form 982 (Part 3)
There is a hidden trap to debt management plans andpaying less than what you owe. Under the IRS rules, someone has realized income from the non-payment of that debt. This is logical, if you think about it. Consider what happens to that $5,000 cash advance if you do not repay it. didn’t you just get the benefit of $5,000? If the creditor doesn’t get repaid, or is repaid less than what you owe, the creditor has suffered a loss and you have realized a gain. That is taxable income.
In two privious posts, we discussed credit counseling, settlements and Debt Management Plans.See Credit counseling and DMPs, Part 1 andWhat is a Debt Management Plan?, Part 2.
So when you settle a debt for 40% of the total balance, expect to receive a Form 1099 showing that you received income for the other 60%. This is the hiden trap of settlement plans or DMPs, if you pay less than what is owed. At the end of the settlements or the DMPs, you will owe the IRS money. Which would you rather owe money to, Visa or the IRS?
Bankruptcy can help you avoid this trap. When you discharge a debt in bankruptcy, you have not realized income. Since you have gained nothing by being broke, you pay no taxes. See Tax Time & the Discharge of Debt. In order to avoid the income trap, you must file a Form 982 from the IRS.