On its face, debt relief sounds like an unconditionally good thing. Who wouldn’t like a little — or a lot — of their debt forgiven? But everything comes with its cost, and debt relief can have a major impact during tax season.
Read on to learn about some effects of debt relief you may not have considered — and how to make plans for April. Keep in mind that tax laws change swiftly, so check with your online tax service to learn about the most recent regulations.
Many debtors don’t know that the IRS considers forgiven debts above $600 to be income, just like wages or interest. And like any income, the IRS expects a cut. Check with your online tax service.
You can expect to pay taxes on your forgiven debts — anywhere between 10% and 37% of your income in 2018-19, depending on your tax bracket. (You receive information about this income via a 1099-C Cancellation of Debt form.) And yes, your forgiven debts could push you into a higher tax bracket.
If you’ve received this relief because your debts outweigh your assets (such as when you apply for bankruptcy), you may not need to pay taxes on this money. Some other circumstances may also cause your debt relief to not count as taxable income, so check with your online tax service.
But if those circumstances don’t apply, you might see a smaller refund during tax season. And at worst, you could find yourself suddenly owing more money at the end of the year than you expected.
If you’re lucky enough to get your debts forgiven, follow this advice to make sure tax season goes smoothly for you:
Put aside some extra money. It may be hard, but try to put aside some extra money to pay your taxes.
Claim fewer allowances. If you get debt relief, think about filing a new W-4 withholding form, so you claim fewer allowances. This way, your employer will withhold more money toward your taxes. You’ll take home less money from each paycheck, but you’ll be less likely to owe in April.
Check with your online tax service. Even if you’ve just dug your way out of debt, you can still take advantage of online tax services like everyone else! Most services will give you advice on how to navigate your new financial situation.
Debt relief is a tremendous windfall, but it can bring new tax challenges into your life. By staying abreast of the law, planning ahead, and working with your online tax service, you can meet your tax obligations in April.
Advertising Disclaimer: Simple. Thrifty. Living. does receive compensation for some of the services that we recommend, although we only recommend services that we truly believe are the best.