21. I have heard I have to pay income tax on the settled amount, is that right?
You may or may not and each individual case is different. We always recommend that you consult with you CPA for their recommendation. Every time a debt is settled the creditor may choose to write the difference off for their tax purposes. You will receive a 1099-C form from the creditor showing the difference settled as income.
If a client had a $10,000.00 debt settled for $5,500.00 then the 1099-C would show income in the amount of $4,500.00 for tax purposes. If at the time of settlement a client’s debts exceed their assets they are considered insolvent by the IRS and no income is attributed. In the event the client is not insolvent, the settled difference would be attributed as income for the year and tax paid on that portion based upon your tax bracket.
In reality, even if tax is paid you are still paying back far less then was owed to the creditor and eliminating the interest.