Debt Settlement and Taxes

Many people turn toward debt settlement to reduce their debt obligations and get their credit back in line so they can eventually finance a vehicle or a home. What some people do not consider is how debt settlement can impact taxes. When a debt is settled, the company settling the debt has the right to send the debtor a 1099-MISC tax form reporting the amount that was saved on the total debt. This is because the IRS sees the money the debtor saved on the debt as taxable income.

What Does a 1099-MISC Mean for Your Tax Return?

A 1099-MISC tax form reports income you’ve earned from sources other than employment. The income reported on these forms has not already been taxed and, therefore, could increase the debtor’s overall tax liability, depending on a variety of factors. If the debtor doesn’t have a lot of withholding throughout the course of the year and/or has a lot of income from debt settlement reported on the 1099, it could eat right through any refund the debtor may otherwise have had due.

What You Can Do to Combat the Issues

Save money. Put some money aside throughout the year to compensate for what taxes may be owed as a result of debt settlement. The money in the savings account could be an “instant” refund if there is no tax owed. If employed, you could adjust your withholding amount so the IRS takes just a little bit more money from each paycheck. How much adjustment needs to be made or extra cash needs to be saved will depend greatly on the total amount saved through debt settlement. If the debtor settles one or two small debts, it shouldn’t make much of a difference. It’s when the debtor settles large debts or several small debts that the money can add up.

Is Debt Settlement Worth It?

Unfortunately, there is not a clear-cut answer here. It will depend on the individual situation of the person who is trying to get out of debt and if this person is willing to save money or make adjustments to withholding to lessen the blow of the tax liability. Oftentimes, people believe that dealing with the penalty from the IRS for one tax season is worth the long-term benefits of getting out from under debt through settlement.

What’s important is that debtors recognize and understand the potential implications of debt settlement on their taxes. It’s when the debtor doesn’t know what to expect and doesn’t prepare for the additional tax liability that debt settlement doesn’t help people. For those who have concerns, consult a debt settlement specialist and a tax professional before making any moves.

Wage Assignment

A wage assignment occurs when an employee has a certain amount of money deducted directly from her paycheck in order to pay a third party. The employer handles the transaction, and the employee never actually takes possession of the money.

A wage assignment can come in two varieties. An individual could voluntarily choose to assign her wages to something, or she could involuntarily have a wage assignment. With a voluntary wage assignment, the employee asks the employer to assign her wages to a particular payment. This could be done to voluntarily pay for child support, taxes or some other type of debt.

With an involuntary wage assignment, a court order mandates that part of the money from her wages be used to pay a particular obligation. This is also sometimes referred to as a wage garnishment.

Typically, a wage assignment occurs as a result of an individual's not paying child support or taxes. The judge will issue a judgement against the individual and will set up a wage assignment for her. The wage garnishment will generally be based on the amount of money that she makes and will also have to leave her a certain percentage to live on. 

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