Debt settlement with collection creditor or bankruptcy? Please share your opinion

[Scarlett1234]

Hi, I made a post before about my SO consider filing bankruptcy. But recently I came across many news suggest now is a good time to settle debt with collectors and creditors because we are in a pandemic and they are more willing to settle to prevent further loss. It sounds less scary than bankruptcy to me but I don't know anything about it neither. If we can get a small percentage negotiated , we might be able to afford the payment plan because of the extended unemployment benifits .Can someone please share your opinion and experience with both?
If he can negotiate the debt with creditor and collectors and get the agreement in writing, thats all it needs? What is the better safe way to make the payment? Check? Money order? Are there any other pitfalls?
I also saw some stories online, it is saying even if you settle the debt with collector, people are still being haunted with the same debt years and years later because the debt has been sold multiple times to many different collectors. That is the worst nightmare. If his debt were to sold to many different collectors, how can we decide who is the legit one to make payments to? Does he have to pay more than one collectors？
If the debt is still new and are with the first collector and if he is able to settle, will the likelihood of many collectors demands payments on the same debt reduce? Are there anything else he can do to ensure the paid debts won't haunt him after he settles?
How can I determine if the debt is owed by a creditor or a collector? If he just calls and asks creditor about this, will they truthfully tell him? I am worried the creditor might accept the settlement to get the money then later tells him, the debt is owned by the collector, so he needs to go pay twice. There is no collection listed on his credit report as of today. Most debts are 150-180 days past due. This whole situation is so depressing and scary, for us who never dealt with this before.
Is it necessary to hire a lawyer to settle the debt just so the lawyer can make sure the agreement looks right and work as a legal binding contract ?I am not too worried about settling with the creditor but are worried about shady collectors who may trick him. I don't know how much the debt settlement lawyer would cost .
Please forgive my ignorance. I never owed anything in my life till this point after my SO made many poor mistakes. Any insight is highly appreciated.

[shipo]

Simply put, Chapter 7 or Chapter 13 is the only way to assure the debt is Discharged or cancelled. One other benefit of a bankruptcy is you will not owe taxes to the IRS for the cancelled debt; if you negotiate the outstanding debt down, even a little, you WILL get a 1099-C for the portion written off by the lender, and as far as the IRS is concerned, that is taxable income.

[Scarlett1234]

I understand the security features come with bankruptcy ,but it makes me so sad thinking about him having to file,the debt settlement makes feel better somehow ,but you are saying the debt settlement would be very risky no matter how i approach it or do it ? Even if it is done between the original creditor and him with no collector involved? Thank you

[Scarlett1234]

I heard of the written off debt would be reported as income ,he is unemployed and have no earned income , so the next year when he file tax , the only income would be unemployment , that base number is low ,if we adds 20000-30000 forgiven debt on top of that , that would make his income around below 70000 for the whole year , how much tax that will generate ? Will it be like 20% of that total income ? Or he has to pay the whole amount of the forgiven debt to IRS?

[shipo]

Scarlett1234, first, a disclaimer; I've never gone the debt settlement route, but I do know two individuals who have; one had junk debt buyers following him around for years, even though he "settled" with the original creditor, the other hasn't said anything one way or another. Is it possible your significant other can settle once and be clear? Yes. Is it guaranteed? No; the only way to do that is bankruptcy, or to pay the debts in full.

[Scarlett1234]

Thank you for sharing these examples with me . If the debt is sold to the collectors , pay the debts in full might still leads to the junk debt buyer follow around too ? I am just really concerned the bankruptcy might hurt his future jobs ,and also because of the unemployment he is getting now , it may not qualify for chapter 7 depends on the disposable income , and chapter 13 normally wont be built on unemployment income as it is short term , i fear his case will just be dismissed if he files now . If he waits till unemployment runs out , then file , would him be accused of "timing hinder delay " all those things people talk about on here ? He already proposed a offer to one creditor through mail , if the creditor agrees and signs it , he will have to pay right as that is a binding contract now , can he still declare bankruptcy if creditors agrees to his proposed and signed debt settlement?

[Scarlett1234]

justbroke I remember seeing you made a comment once that when you were younger ,you did settlement , can you share your experience or opinion please?

[justbroke]

Scarlett1234 that must have been some other broke person. A very long time ago I tried CCS consumer counseling and my vague memories of that are that it didn't work at all.

The problems with debt settlement are exactly those that you mentioned in your initial post. Debt settlement has to be done a certain way, and in a writing, so as not to create zombie debt (where the difference in the settlement is just sold to some other debt collector). I would either work through a company that specializes in debt settlement combined with debt consolidation or find a cheap attorney that does these things.

You must also remember that if the debt is truly forgiven, expect an IRS 1099-C (Forgiveness of Debt) and taxes to boot.

In the end, bankruptcy is the only way to guarantee that the debt is forever gone (by operation of law) and that there will be no taxes.

[Scarlett1234]

Thank you. I have seen mixed opinions , most people says bankruptcy is better ,there are some believes debt settlement is better if it can de done correctly especially if done with the original creditor .I am still trying to decide .

[justbroke]

Scarlett1234 being done "correctly" is the operative word and one which is not defined. Most people that do debt settlement or consumer counseling, end up in bankruptcy. Many people don't understand the tax impact of debt settlement and the subsequently issues IRS 1099-C.

Bankruptcy is the only manner to deal with debt which has finality and the force of the U.S. District (Bankruptcy) Court to back it. Negotiating settlements can be difficult and even if you worded it correctly -- avoiding the trap that the creditor sells the balance to yet another collection agency -- you have the tax impact.

For smaller amounts, the tax impact may not be significant. But dealing with a larger amount, the tax can be significant. Consider debt settlement on a $100,000 deficiency with a bank. You settle for $10,000. A total of $90,000 is forgiven and an IRS 1099-C is issued. You now owe taxes on $90,000 at your marginal tax rate. That tax would be over $12,000 for a single person with no other deductions. That's a lot of money. Banks may also ask for financials when the amount is significant. This is to make sure that you're not just trying to settle for 10% when you actually have 100% of the money (liquid or otherwise).

That's what makes settlement more complex and potentially more costly than expected.

[Scarlett1234]

Thanks .I looked up the exceptions to the IRS 1099-C ,it seems like he has very little assets that he might qualify for the insolvent and not have to pay tax or pay very little on debt forgiven ,the example I found was saying if he only owns 3000 asset and his forgiven debt amount is 30000 ,then he would only report the 3000 as income and pay tax on that for 1099c purpose .Have you heard of that ? Otherwise, the tax does seem heavy. My concern is more about if debt would be settled correctly , I didn't know the creditor would sell the forgiven debt balance to other collectors, I thought only the debt collectors will play dirty, do you mean I need watch out for both when settle debt ?

[shipo]

Scarlett1234, I don't believe it works that way, my understanding is, unless he files for bankruptcy, regardless of his assets, if he has $30,000 of debt forgiven, then the 1099-C will be for $30,000 of "income", and that plus his marginal tax rate will become the basis for calculating the taxes the IRS will absolutely, positively, require him to pay.

[Scarlett1234]

That would be a lot to pay on tax . I will have to research on this matter .

[shipo]

Scarlett1234, I don't believe there is much to research, if you have debt forgiven by agreement versus bankruptcy, then a 1099-C for the forgiven amount is a simple fact of life.

[Scarlett1234]

I know the form is a fact but more than one place showed the calculation I mentioned , that’s what I am going to double check , “Let’s say you have $20,000 of debt, including the forgiven debt, and you have $12,000 of assets,” Allec says. “You’re insolvent by $8,000. But then let’s say you had $10,000 of that total debt forgiven. You can only exclude $8,000 of that debt because that’s the amount you were insolvent.” So you’d still have to pay taxes on $2,000 worth of income

[justbroke]

Scarlett1234 calculating insolvency for purposes of IRS Form 982 is tricky. To p rove insolvency you must include all of your assets including 401(k)s, IRAs, and other property that may otherwise be out of reach of creditors. If the person has that type of (otherwise) exempt property it is tricky to get a reduction in the amount of the actual debt. Unfortunately it's not so simple as saying that I'm insolvent by $8,000 if I have more than $8,000 in any retirement account or any other asset, combined.

That's why bankruptcy is special. The first checkbox on IRS Form 982 is "discharged under Title 11" (bankruptcy). It doesn't require calculations or trying to determine a person's true liability less value of all property. Everything on that form requires calculations to prove the reason why the tax liability should be reduced or eliminated.

I always refer people to a tax professional (such as a CPA, tax attorney, or an enrolled agent) to help with an IRS Form 982. Unless you filed bankruptcy, you need to make those calculations and it could be a daunting task for some. I know that I wouldn't have considered my "exempt" 401(k) as property in the calculation of whether or not some portion of forgiven debt was subject to a reduction. I would have thought it was "property" such as cars, homes, clothing, furniture and other belongings.

Best to seek professional tax help before going down the path of debt settlement if the numbers are high or could lead to a large tax liability.

[Scarlett1234]

Thanks for your advice, I have been trying to find a good CPA but haven't found any . I understand the point, unfortunately my SO is so young and he has nothing other than clothing and a car with an upside down loan, that's why I feel he might truly be "insolvent" , but bankruptcy is another option he is looking at too. Just trying to learn as much as I can.

[shipo]

I know the form is a fact but more than one place showed the calculation I mentioned , that’s what I am going to double check , “Let’s say you have $20,000 of debt, including the forgiven debt, and you have $12,000 of assets,” Allec says. “You’re insolvent by $8,000. But then let’s say you had $10,000 of that total debt forgiven. You can only exclude $8,000 of that debt because that’s the amount you were insolvent.” So you’d still have to pay taxes on $2,000 worth of income

What we're trying to tell you, and apparently are failing, is that for all intents and purposes, if you have $30,000 in debt forgiven, then you're going to get a 1099-C for $30,000.

[Scarlett1234]

I get that ,but what I have been saying is that 30000 may not turn out to be 30000 if the person has nothing.All i am doing is trust but verify . Like I said , I found the info I quoted , i am not saying you or me either is all right or wrong

[shipo]

Okay, I've tried and failed. Good luck.

[justbroke]

If the debtor has almost nothing to their name but a large amount of debt forgiven, it is possible that they'd be able to reduce the amount of tax due, by showing that they were insolvent. That's the entire purpose of IRS Form 982.

Whether debt settlement is the best business decision will always remain a business decision. I just hope that any debtor that goes down the debt settlement route makes sure that they get offers in writing and that the offer addresses the "deficiency" amount (the balance) in a way that doesn't subject the debtor to further collection activity. That in itself won't prevent a 1099-C, but at least you don't end up with zombie debt.