Will I Owe Taxes If I Settle With A Collector?


Several options with debt collectors can possibly lead to being taxed.

Either you will owe taxes to a debt collector or you won’t. Find out the different paths to being taxed or not taxed.

Will I Owe Taxes If I Settle With A Collector?

Settling with a debt collector can lead to tax issues in several ways.

First, if you sue a debt collector and receive money from the collector, then you may owe taxes on the settlement.

Second, if you pay a debt collector less than the amount the collector claims you owe, you may owe taxes on the amount that was “forgiven”.

Let’s look at these in more detail.

First, if you sue a debt collector and receive money from the collector…

You may owe taxes on the settlement.

The general rule is that unless the money damages are for personal injuries, then the money you receive will be considered income.

Sometimes the entire amount may be considered income.

In this case, you’ll need to get with your tax person to see if you can deduct the amount of attorneys fees from your income.

Now having said this, it is better to have to pay some taxes on some money than to get nothing at all.

You simply need to be aware of this issue and plan for it as you consider the amount that is offered to settle your case.

We do not give our clients advice on this other than to say get with your CPA or tax person to help you.

Second, if you pay a debt collector less than the amount the collector claims you owe…

You may owe taxes on the amount that was “forgiven”.

Here’s the general rule.

If you borrow money, you don’t pay taxes on the money borrowed.

But if you end up not paying it back, then that money will be considered income. ┬áHere’s an example:

You borrow $10,000 from XYZ bank.

You don’t count the $10,000 as income — its a loan, not income.

But you pay it back with after tax dollars so the IRS is happy.

Now, if you don’t pay it back, then the IRS says you had around $10,000 in income more more.

Maybe more if they count interest, etc.

Or if you pay back only $4,000 then you may get hit with $6,000 or more in income.

$10,000 minus $4,000 is $6,000.

So one thing we want to do when we settle a collection case is not pay the collector any money.

If we have filed an Answer denying we owe the collector any money, and if we don’t pay any money, then we have a good argument that no money was forgiven.

One reason when we represent a client sued that we pay no money is the debt collector who sued us doesn’t own the debt so we are not paying them any money.

Keep in mind you need to be aware of possible tax consequences if you settle with a debt collector by yourself.

You don’t want a surprise the following January when you get a 1099 from the debt collector.

Feel free to contact us with any questions you may have

If you live in Alabama and do NOT have an attorney, feel free to reach out to us.

We realize a lot of folks have lawyers that won’t answer their questions but we can’t talk to you.

You need to speak with your lawyer.

You can reach us at 205-879-2447 and we’ll be happy to speak with you.

Or feel free to click the button below.

Thanks!

John Watts
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