If you are dealing with the original creditor, and you work out a settlement for less than you owe, the creditor may send you a 1099-C at the end of the tax year. You are required to report the amount listed on the 1099-C as income.
So how bad is this? Well, it depends on your tax bracket. Income tax is beyond the scope of this book, but briefly, your tax bracket depends on how much income you report, after deductions to the IRS.
Just as an example, and we are not using real numbers here, let’s say:
1. If you are below the poverty line, you don’t pay any taxes.
2. If you make over $35,000 you pay 20% taxes
3. If you make over $50,000, you pay 35% taxes
4. If you make over $70,000 you pay 39% taxes
Let’s also say that you get a $5000 break in your debt settlement. The creditor sends you a 1099-C for $5000 at the end of the year.
You would pay:
1. no extra taxes if your income is below the poverty line
2. $1000 in additional taxes if you are in the 20% bracket (hey, you are still saving $4000 overall by negotiating)
3. $1750 in additional taxes if you are in the 35% bracket
4. $1950 in additional taxes if you are in the 39% bracket
