Does debt consolidation affect your tax return?
Although you can lower your monthly payments and lower your interest fees, it doesn't lower the amount of your debt. Debt consolidation can damage your credit score temporarily, but it doesn't increase your tax burden.
The IRS considers canceled or forgiven debt to be income, the same as your wages or interest earned on your bank account. If, for example, you settled $5,000 in credit card debt for $1,500, the IRS would count the $3,500 in debt forgiveness as part of your income.
There are only four types of debt for which the federal government will withhold your tax refund or send it to one of your creditors. These debts include past-due federal taxes, state income taxes, child support payments and amounts you owe to other federal agencies, such as federal student loans you fail to pay.
If you settle a debt with a lender or collection agency, you can expect to receive a 1099-C.
If you receive a 1099-C, you may have to report the amount shown as taxable income on your income tax return. Because it's considered income, the canceled debt has tax consequences and may lower any tax refund you are due.
In general, if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable. If taxable, you must report the canceled debt on your tax return for the year in which the cancellation occurred.
The general rule regarding taxability of amounts received from settlement of lawsuits and other legal remedies is Internal Revenue Code (IRC) Section 61. This section states all income is taxable from whatever source derived, unless exempted by another section of the code.
The TOP is the only way your refund can be garnished; private creditors such as credit card companies don't have access to your tax refund. Moreover, only certain types of government debts are eligible for TOP. These include: past-due court-ordered child support payments.
And, generally, that debt does not become taxable unless it is discharged (canceled or forgiven). If that debt is discharged, you may well owe taxes on the amount you don't pay back. Loans that are not taxed as income include: Personal loans for credit card consolidation or major purchases.
BFS will send you a notice if an offset occurs. The notice will reflect the original refund amount, your offset amount, the agency receiving the payment, and the address and telephone number of the agency. BFS will notify the IRS of the amount taken from your refund once your refund date has passed.
Is it a good idea to consolidate debt?
Consolidating debt can be a good idea if you have good credit and can qualify for better terms than what you have now and you can afford the new monthly payments. However, you might think twice about it if your credit needs some work, your debt burden is small or your debt situation is dire.
Banks, credit unions, and installment loan lenders may offer debt consolidation loans. These loans convert many of your debts into one loan payment, simplifying how many payments you have to make. These offers also might be for lower interest rates than what you're currently paying.
In most situations, you must report the income shown on Form 1099 when filing your federal income tax return. – Your Consolidated Form 1099 (rather than your December statement) is the official document for tax reporting purposes.
The creditor that sent you the 1099-C also sent a copy to the IRS. If you don't acknowledge the form and income on your own tax filing, it could raise a red flag. Red flags could result in an audit or having to prove to the IRS later that you didn't owe taxes on that money.
The issuance of the 1099C does not even mean that the creditor cannot still collect the debt. There are ways to avoid having to pay tax upon the amount of debt written off or forgiven, though. This question and answer can also be found on Justia's “Ask a Lawyer” page.
You will need to research exceptions and exclusions that may apply to your particular case, in order to avoid paying taxes on the given amount. Debt canceled due to inability to pay is a common exclusion used by taxpayers to avoid paying taxes on canceled debt, along with bankruptcy.
There are no direct taxes on a debt settlement, but if you save $600 or more, you will have to report the savings as income.
The IRS Fresh Start program is a set of initiatives that the IRS offers to help taxpayers who are struggling to pay their taxes. These initiatives include payment plans, streamlined procedures for filing taxes, and more. If you owe taxes and are struggling to pay them, the IRS Fresh Start Program may help you.
Debt Forgiveness May Raise Your Taxable Income
Debt forgiveness may also have some tax consequences. The amount that's forgiven will be counted as income on your upcoming tax return, which means you may have to pay income tax on it.
According to the IRS, your taxable income does not include the following: Settlement money you receive from claims involving unspecified physical injuries. Benefit payments you receive from your employer's workers' compensation insurance. Money you get through your health insurance for covered medical expenses.
Do I have to report settlement money to IRS?
General rule relative to taxability of amounts received from lawsuit settlements is IRC §61 that states that all income is taxable from whatever source derived, unless exempted by another section of the Code.
However, victims are not taxed if the lost wages are a result of the physical injury at issue. Emotional distress. If a victim is awarded damages solely for emotional or mental distress, the damages are subject to taxation by the federal government.
Your tax return may show you're due a refund from the IRS. However, if you owe a federal tax debt from a prior tax year, or a debt to another federal agency, or certain debts under state law, the IRS may keep (offset) some or all your tax refund to pay your debt.
Private collection agencies cannot take any type of enforcement action against you to collect your debt. However, the IRS does have the legal authority to file a Notice of Federal Tax Lien or issue a levy to collect an overdue account.
Collection activities are currently paused for all federal student loans through September 2024, which should protect your 2022 and 2023 federal and state tax refunds.
