Many of our students are looking to Debt Settlement Companies to negotiate for them to try to get a reduction on their debt load. Typically that would only include their credit card unsecured debt. We see a lot of claims from these companies in the media nearly from dawn to dark. Working with these companies can cost a lot. The point is that many of our students could save that fee, which is usually at least 15-20% of the amount “settled�. I recommend that you call your credit card companies yourself and explain that you are having trouble with meeting all of your obligations for whatever reason(s) and ask if they will work with you in reducing the monthly payments and/or the interest rates on the account. Most of them will work with you simply if you ask. Some will ask you to fax or mail a “hardship letter� to explain the reasons you can’t make the required payments. Some however will work with you right over the phone. It makes sense to try this approach first and save the hefty 15-20% fee that the debt settlement companies would charge you for this service.
Some of the companies will promise huge reductions in your debt but only if you can come up with the money for an immediate settlement. Often times they will discount the total amount due as much as 40% or more in order to get the money now and settle the account. However the law also requires them to file a 1099-C form with the IRS detailing the amount of debt that was forgiven, and it will be fully taxable the following April to the debtor. If your debt is settled for 50 or 60% of the original amount, that can make a sizeable tax bill you will have to deal with on your next tax return.
For these reasons, I suggest that you try to work with and do the settlement yourself. If that fails, usually you will still have the option to go back to a settlement company if you feel like the hefty fee is worth it. Regarding your credit, using such a company will have some ramifications. Communicating with these companies is almost always a better approach than ignoring them or hiding from all the pestering phone calls. A few of my students have negotiated very satisfying arrangements with their individual creditors and saved the headache and frustration of ruined credit and adverse future credit reports. Even if you send in smaller payments over a longer period, most creditors will continue to work with you under favorable circumstances if they know you are trying to make good on your debts.
You may not have to pay tax on the amount forgiven if your insolvent per IRC Sec. 108(a). Before settling on your debt, calculate your net worth. Make a list all of your assets and liabilities and keep this for your records. Do you have negative net worth? Are you unable to keep up with your minimum payments? Then you’re probably insolvent and the amount forgiven won’t be taxable, as long as you’re insolvent immediately before the settlement. Because you get the 1099-C, I would still report the amount on your return. You don’t want to get an IRS matching notice because the amount wasn’t reported. However, you can then back it out and state something like “less amount not taxable under irc sec. 108(a)”. Consult your tax advisor.