Debt Settlement and Its Implications on Taxes

Debt Settlement: A Guide for Negotiation

Getting overwhelmed by debts and tax dues is quite a common issue faced by millions of people in the country. People facing a difficult time paying what they owe the IRS or some other creditor can turn to a debt settlement facility, which can help them clear all dues in a very short period. For tax debts, this can be in the form of an IRS installment agreement. While debt settlement is an excellent solution when looking for debt relief, there are some implications to availing this option. Let’s take a closer look at some of them.

What is meant by Debt Settlement?

Debt settlement refers to an agreement between the lender and the borrower that allows the latter to settle their debt for a smaller amount than what they owe. While this lets the borrowers clear their dues for a reduced amount, it allows the lenders to get at least a part of the total amount, as opposed to not receiving anything and proceeding through costly collection processes. This, however, doesn’t allow the borrower to get away without facing any implications. Debt settlement shows up on your credit report and negatively impacts your credit score while possibly being troublesome when applying for loans as well.

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What are the Potential Tax Implications Of Clearing Debts?

The debt cleared might lead to your creditor sending you a 1099-C cancellation of debt tax notice, which requires you to show this amount as “other income” on your tax return that you file with the IRS. Even if you don’t receive a 1099-C, you must report the canceled debt as income. Although you must deal with the taxes for the amount, there are a few tax relief options available that you can also avail.

What Is The Amount You Need To Pay?

The amount you need to pay is calculated as per the normal tax rate, which varies depending on your taxable income and ranges from 10% to 37% as for the 2020 tax year. The US has a progressive tax rate, which means the tax percentage increases as the taxable base increases. That means individuals with higher incomes deal with huge taxes even when they are running low on funds.

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What Happens If You Decide To Refrain From Reporting?

As per the legal guidelines, taxpayers must report all their taxable incomes, including any debt settlements. When you receive a 1099-C, the IRS is also informed about your debt settlement, making it imperative for you to report it. In the event that you don’t report, you will not only have to pay your tax dues but also fines for failing to report your debt settlement. On the other hand, if you don’t receive a 1099-C, the IRS doesn’t get to know about your debt settlement. However, if you ever are chosen for an audit, the settlement amount can be detected and potentially lead to legal action. It is highly recommended to inform the IRS about the settlement yourself to make sure you’re legally safe and don’t need to worry about potential legalities in the future.


For individuals that need help with the tax issues related to debt settlement, it is highly recommended to hire a IRS tax lawyer to help you with the complex legal procedure. The proficient team of professionals at the Law Offices of Nick Nemeth is known for providing the best solutions when it comes to IRS debt relief in Dallas through avenues such as IRS installment agreement. Call (972) 635-4098 for a free consultation today and get answers to all your questions about IRS payment agreements in Dallas! You can also fill our Contact Form or email

Debt Settlement and Its Implications on Taxes
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