Does settling a judgement have tax consequences?

[Tesla2016 0]

I'm curious . . .

If a creditor sues, wins and obtains a judgement against a debtor for X amount, then the creditor agrees to accept a smaller amount from debtor (say, 60% of judgement amount) as settlement of the debt.  Is the difference (40%) treated as taxable "income" by the IRS?

 

[Clydesmom 1,189]

5 hours ago, Tesla2016 said:

If a creditor sues, wins and obtains a judgement against a debtor for X amount, then the creditor agrees to accept a smaller amount from debtor (say, 60% of judgement amount) as settlement of the debt.  Is the difference (40%) treated as taxable "income" by the IRS?

Depends on how much the 40% is in actual dollars.  If the amount in question is $600 or more under IRS regulations it is supposed to be declared as income by the debtor on their taxes via a 1099-C.  Now the IRS certainly doesn't have the budget or personnel to chase down every debt so unless it is reported or is a significant amount they are not likely to notice.  These regulations are why many settlement agreements include wording that states "no 1099-C" to be issued.

[Tesla2016 0]

Thanks Clydesmom.

I finally took the time to look it up, and it seems that the debt amount canceled is considered ordinary income. So it would not be taxed any higher than ordinary wages.  I'm thinking that if someone needs to file BK is because they're not making enough money, so they're probably in a lower tax bracket, and therefore don't have to pay a lot i taxes.  So why is everyone so averse to receiving a 1099-C?

What am I missing? 

By the way, Could you point me to a sample settlement agreement?

Thanks!

[Clydesmom 1,189]

1 hour ago, Tesla2016 said:

I'm thinking that if someone needs to file BK is because they're not making enough money, so they're probably in a lower tax bracket, and therefore don't have to pay a lot i taxes.  So why is everyone so averse to receiving a 1099-C?

If you are insolvent at the time the debt is settled and a 1099-C is issued there is a special IRS form for insolvency that you can file at the same time that literally wipes out the tax debt for that reason.  

Those who are completely adverse are the ones who have a large amount forgiven or settled that puts them into another tax bracket and they end up owing the IRS thousands in penalties, taxes, and interest.

1 hour ago, Tesla2016 said:

By the way, Could you point me to a sample settlement agreement?

Check your private messages.

[Tesla2016 0]

Thanks!