Debt settlement may be a viable option if a person has a small number of creditors and/or has exempt property that cannot be protected in bankruptcy. Generally, if you are current on the account, many times the creditor will not settle with you because it has no incentive to reduce a performing account. If you are in default or if you have been sued, depending on the creditor and the defenses that can be raised by you, settlement may be an attractive alternative. One major disadvantage of debt settlement is that it may create “cancellation of debt income.” This means you could incur tax liability for the portion of the debt that is forgiven as part of the settlement. For example: you owe $40,000 on a credit card which is settled for $10,000. The credit card company sends a 1099 to the IRS and you are taxed on $30,000 additional income. There are exceptions to this taxation, including insolvency. So, see your tax professional on this. If a debt is forgiven through a bankruptcy, generally, there is no “cancellation of debt income.” There are exceptions to this though and the timing of the bankruptcy and the 1099 is important. Another drawback of debt settlement is that your credit may be hurt by the charged off debt.
Use Caution Hiring Internet Companies for Debt Settlement
In these crazy economic times, television and other media are filled with commercials advertising for debt reduction by debt settlement companies. USE CAUTION in going this route. One frequent scenario with a debt settlement company is they have you stop paying all your unsecured debt, such as credit cards and signature loans. Instead, you pay the company for a number of months for their fee for future services. This will obviously cause your credit cards to go to a default rate if they are not there already. You may also be sued by your creditors. There is no guarantee that the debt settlement company will be able to settle your debts by reducing principal or interest.
The Federal Trade Commission sets out the pros and cons of settling credit card debt, as well as what the debtor should expect in dealing with a debt settlement company. Extreme care should be taken before signing up for one of these programs. Read the fine print. Make sure they are reputable and understand how your monthly payment is going to be allocated and what fees you will be paying.
Again, this is an area full of scammers. For example, On March 28, 2009, the Texas Attorney General announced that a lawsuit was being filed against a Richardson debt settlement company, Credit Solutions of America. This company is accused of having debtors stop making payments to creditors, and then not being able to obtain reductions on accounts as they had promised their clients.