Bankruptcy Blog

Bankruptcy and Next Year’s Taxes

by Scott Kainrath 4. March 2012 06:23
Filing Bankruptcy may allow debtors to get rid of most, if not all, of their debt, but it also offers a major advantage over negotiating with creditors to reduce the amount you owe on your debts.  The advantage lies in your next year’s tax return.
 
In addition to getting rid of debt from filing bankruptcy, the debts forgiven in bankruptcy are never taxable. However, debts forgiven outside of bankruptcy typically create a tax liability for the debtor.
The major problem with credit card debt settlement is that the forgiven debt is treated as income by the IRS. This means that if the debtor negotiates with the creditor to pay back a fraction of the debt owed, then they will have to claim the forgiven part on their following year’s taxes.  For instance, if you owe $20,000 in credit card debt, but you are able to reach a settlement with the credit card company to pay back only $8,000 of that debt, you must claim the forgiven $12,000 as income on your next tax return. You will then need to pay taxes on that $12,000.
Before a debtor decides to seek debt forgiveness outside of bankruptcy, they should consult with a bankruptcy attorney to closely examine how such a move will impact their tax liability.

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