The Center For Debt Management
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Three Common Objections To
Consumer Debt Settlement

There are three main objections to consumer debt settlement: the possibility of lawsuits, the damage to credit history and the resulting IRS tax consequences of debt foregiveness.

Creditors May Elect To File A Lawsuit

A debt settlement company does not make monthly payments on the debtor's accounts, thus the debtor's accounts remain in default. While the debts are in default the creditor or its assignee can file a lawsuit against a debtor. Most creditors and debt collectors want a lump sum payment to settle for less than the full debt. Although a debtor may make monthly payments to a special savings account or trust fund, the amount is too small to successfully negotiate a settlement until after the debtor has saved sufficient funds to start to settle his or her debts. Depending on many factors, including the number and total amount of debt, and the debtor's ability to build up funds, it may takes years before the debt settlement company can settle all of the debts. In the meantime, void of receiving any payments whatsoever, a creditor may elect to file a lawsuit against the debtor.

At any time during the process a creditor may elect to file a lawsuit. It must be understood, however, that the same applies whether or not the debtor has enrolled with a debt settlement company. Simply stated, if an account is in default, a creditor can take legal action.

Today, most professional debt settlement companies have attorneys on staff, and in fact, the best debt settlement companies are actually law firms. A good debt settlement company should take appropriate steps to avoid any lawsuits. In reality, however, in most cases the bottom line depends on the debtor's financial situation and his or her ability to pay off the debts owed. If the debtor is truly deep in debt and unable to meet the demands of the creditors, despite the attempt to resolve it amicably through debt settlements, ultimately the debtor may be faced with filing for bankruptcy —which will effectively stop any lawsuit. On the other hand, many debtors who were deep in debt have been able to sucessfully resolve their financial troubles through debt settlements over an extended period of time —and without ever having any lawsuits filed against them.

Effects of Debt Settlements
Will Tarnish The Debtor's Credit History

Due to the debt settlement process the debtor's credit report gets tarnished. A credit report is used by creditors to judge past credit performance to see if the applicant meet their criteria for lending. Insurance companies uses a person's credit report to determine premiums and prospective employers review the credit report to establish the character of a job candidate. Having an unblemished credit history should be an objective of everyone!

Today, most debtors who qualify for enrollment in a debt settlement program must suffer severe financial hardship. In fact, in most cases, they are prime candidates for bankruptcy. But, they also believe that filing for bankruptcy should be a last resort, and in reality, enrolling in a debt settlement program may be their only other alternative.

The bottom line is, chances are, debtors who qualify for enrollment in a debt settlement program already have a very tarnished credit report, and if for some reason they don't, it will likely be tarnished in the very near future with or without enrollment in a debt settlement program. If this is not the case, they should not be considered as a viable candidate for debt settlement program.

On a positive note, if the debtor is able to successfully complete the program, which typically takes considerably less time to achieve than enrollment in a Consumer Credit Counseling debt management program — and which will also tarnish a credit report — he or she will be debt free, and in time derogatory information on the credit report will be removed and the consumer will be able to eventually re-establish a good credit history, and one to be proud of!

Tax Consequences

Another common objection to debt settlement is that debtors whose debts are partially canceled outside the bankruptcy system will need to report the canceled portion of the debt as taxable income.

The IRS considers $600 or more of forgiven debt as taxable income. The forgiving creditor must provide the taxpayer with a 1099-C tax form. The form will list the amount of forgiven debt and accumulated interest in Box 2. Taxpayers with portions of personal loans forgiven may not subtract the interest reported in Box 3 from the amount of reportable income on this form.

The IRS, however, does not require taxpayers to report forgiven debt if the tax payer was insolvent at the time the creditor forgave the debt. Being insolvent means that the amount of a debtor’s debts are greater than his or her assets, that is, how much money and property the debtor owns. However, the IRS adds that “you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent.”

For example, if a taxpayer is $25,000 in debt and owns $5,000 in assets, he or she cannot exclude more than $20,000 of forgiven debt from his or her income tax. Any forgiven debt over $20,000 that year must be reported as taxable income.

Most debtors who enroll in a debt settlement program are insolvent, or have little assets, however, even if paying taxes are required, the bottom line is, becoming debt free and the savings achieved through the debt settlement process typically out-weight the consequences of paying taxes to the IRS.

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