One of the really, really important things people don’t know about filing bankruptcy is how bankruptcy relates to federal income tax. In earlier blogs, I spent some time discussing debt settlement agencies and credit counseling bureaus, and why I don’t think either of those places is where you want to go first when you have debt issues. One of the most important reasons I think that way is that, if you make an agreement with a creditor to settle up with you for less money than you really owe them, income tax comes right into the picture, that very tax year. In other words, the portion of the debt you don’t pay back to your creditors has to be included on your tax return as taxable income, just as if you earned that money! Then, depending upon how much the amount is that is “forgiven”, your tax bracket could be bumped up higher and you could be paying a higher percentage tax on all your income! (Talk about a double whammy!)
Now, the truly interesting fact is that if debts are discharged (actually “forgiven”, but in this case through the court system), there’s no taxable income. There are actually other factors besides tax considerations in favor of filing bankruptcy rather than negotiating a settlement with the creditors, but avoiding the tax “double whammy” has to be near the top of the list!
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This post was written by Mark