Insolvency CPAs see tax problems with clients who negotiated credit card debt cancellation. But some new clients don’t realize that cancelled credit card debt becomes taxable income. So I’ll touch on four main issues:
- Dealing with the credit card companies.
- Tax problems arising from cancelled debt, including federal tax forms 1099-C, Cancellation of Debt and 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).
- Cash flow planning.
- Cancelled debt strategies
Dealing with Credit Card Companies
I don’t deal with credit card companies unless there’s a tax issue involved. See the tax strategy below.
Here’s few issues cancelled credit card debt clients have shared with me over the years.
- Stop paying the credit card companies. It can take several months of non-payment for them to get serious about negotiating.
- Prepare for months of disheartening phone calls. These include threats to sue.
- Continually mention you can’t pay.
- Document every contact.
- Some credit card negotiators say never admit the debt is yours.
- Offer a cash settlement if possible, usually at the end of the fourth or fifth month.
- Never give them additional information.
- Mention potential bankruptcy. Do your homework on what that mean to the credit card company. If they’ll get $15,000 through bankruptcy, an offer of $18,000 now seems attractive.
Tax problems arising from cancelled debt including federal tax forms 1099-C, Cancellation of Debt, and 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)
Your credit score will plummet. You essentially have all the post settlement credit consequences as going bankrupt.
“Some folks don’t realize cancelled credit card debt incurs tax problems.”
- Gary Bode, cancelled debt CPA
Eventually you’ll receive federal tax Form 1099-C. The amount of cancelled credit card debt appears in Box 2. Check that number carefully. At this point you’ll owe tax on the amount in Box 2. I know that seems unfair. I ballpark the tax due at 25-30% of 1099-C’s Box 2. So $10,000 of debt cancellation can mean $2,500-3,000 of tax liability. Ouch.
But some of that cancelled credit card debt from Form 1099-C might be excluded from taxable income, by using federal tax Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment). The name alone scares folks. But the Insolvency provision of Form 982 is the only way to exclude cancelled credit card debt from taxable income. Insolvency for IRS purposes doesn’t mean bankruptcy.
Cash Flow with Credit Card Cancellation of Debt
- Generally the credit card companies require a cash settlement. But I hear they might take that in installment payments.
- You’ll have an IRS tax problem that might require payment of 25-30% on the amount listed in 1099-Cs Box 2.
- You may have State taxes due from cancelled credit card debt.
Tax Strategy for Cancelled Credit Card Debt
Have as few assets as possible when finalizing the credit card cancelled debt settlement. Why? Being insolvent by the IRS definition can avoid cancelled credit card becoming taxable income on Form 982.
I’m an Insolvency CPA who deals with all types of cancelled debt from federal tax Form 1099-C and Form 982. Our virtual office allows us to serve you regardless of location. Call for a free phone consult. (910) 399 2705.
Here’s a link that might help.
- specific Form 982 example for cancelled credit card debt.