Should You Take Advantage of Debt Forgiveness?

Illustration of a person handcuffed to a dollar bill to illustrate debt forgiveness.Schools, institutions, and other lenders are in the news for writing off their balances owed, thereby forgiving the debt. What are the consequences of debt forgiveness, and should you take advantage of debt forgiveness offered by a creditor?

While it is true that when a debt is forgiven in whole or in part, you are no longer required to repay that portion of the debt. However, did you know that the lender or creditor may issue a statement that the debt was forgiven? In fact, for many, the lender must issue a statement and report the forgiveness to the IRS by issuing a 1099.

That is, of course, if the debt exceeds $600.

If the creditor complies with IRS regulations and issues a 1099, depending on your tax rate and the amount forgiven, you may end up facing a hefty tax bill.

Can You Afford the Tax Due on the Forgiven Debt?

Will the increase of the write-off — now considered income — cause a change in your tax rate, and cause you to lose some deductions that winds up costing you more money than it’s worth? Another consideration is whether you have (or could borrow) the monies to pay the tax owed resulting from the write-off.

The tax owed on the forgiven debt is due when filing your taxes unless you arrange otherwise with the IRS. The debt is not payable in installments. The government usually is not as “understanding” as a creditor when it comes to accepting payment arrangements.

Assuming the write off is substantial and you do not have the monies to pay the tax, what do you do? Do you avail yourself of the creditor’s offer to forgive the debt? Do you repay the debt on a long term plan?

The Mortgage Forgiveness Debt Relief Act of 2007

The act allows taxpayers to exclude income from the discharge of debt on their principal residence. According to the IRS, debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief. This provision applies to debt forgiven in calendar years 2007 through 2017. Up to $2 million of forgiven debt is eligible for this exclusion, or $1 million if married and filing separately. “The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition,” the IRS says.

An offer for a creditor to forgive a debt may seem attractive. But considering all the implications, that might not be the case.

Consider those entered into lower-paying careers in exchange for qualifying for student loan forgiveness as part of Congress’ student loan forgiveness program in 2007. And, the reality that 99% of those in the program ultimately qualified for forgiveness.

About the author: Jocelyn Nager manages Frank, Frank, Goldstein & Nager, P.C., a law firm devoted to the collection of bad debt. Jocelyn blogs weekly about tips to collect bad debt, court practices and more to educate and assist creditors to prevent bad debt.