Of all the threats that I've seen payday loan collectors try, this is one of the strangest. It happened a while ago.
A woman I know showed me a letter. A payday loan place, where she'd borrowed some money months before, had been sending her threatening letters asking her to pay because, well, she needed to pay. Finally, they sent her a letter that said, in effect, we've given up collecting, so now we're reporting you to the IRS.
She asked me what I thought it meant, and we both agreed. It was actually funny.
If you're lucky enough to get a debt settlement or debt cancellation agreement with a lender, it means they've decided to quit collecting and are going to just write off your debt. This is what the payday loan place had done, without even asking. Sometimes you get lucky.
For a big debt, like a credit card balance in the thousands of dollars, you can sometimes negotiate debt settlement if you pay a lump sum that's less than half the debt, and the bank will consider it paid in full and write off the rest.
For a small amount, like hers was, the lender apparently decided it wasn't worth trying to collect anymore and wasn't even worth selling, so they were just giving up and not expecting that she'd pay anything. But as a final scare tactic, and maybe just because they were pissed at not being able to collect, they sent her the letter about reporting her to the IRS.
Well, duh. When a company agrees to debt settlement or to cancel a debt, whatever they forgive is considered part of your income by the IRS. I guess the IRS figures if you worked that hard to get a debt collector to stop hassling you, you must have earned it. If the lender wrote off more than $600, whether it's payday loans, credit cards, a mortgage, or whatever, the lender is required to file a Form 1099-C, Cancellation of Debt. You'll receive a copy early the next year, about the same time as your W-2 and all that other tax stuff.
This is all perfectly legal and normal, even though it's annoying. You haven't done anything wrong and won't get in trouble with the IRS, unless you don't report the amount on the 1099-C correctly to them.
So the worst thing that'll happen is you'll need to pay tax on the amount of debt that got written off in the debt settlement or cancelled. Paying a tax of 15% or even 25% is a lot better than having to pay the whole thing, and if you don't earn much and the debt cancellation wasn't a large amount, it might not raise your taxes hardly at all.
Sometimes You Don't Even Have to Pay Taxes
If the debt settlement is on your home mortgage, or a few other things, you may not even have to count the forgiven debt as income, according to the IRS. They have an article about it here.
There other exceptions where you don't have to pay taxes too, like if the debt is discharged because you filed bankruptcy. Another category is non-recourse loans. Car title loans may fall in that category (not regular car loans, the short-term car title kind, but check to see for sure). A non-recourse loan means that all they can do is repossess the car or whatever you put up as collateral, but if it isn't worth as much as the loan, they can't come after you personally for it. Lawsuit settlement loans are another kind that's non-recourse, and of course pawn-shop loans too, though when have pawn shops ever loaned more than the value of what you give them?
If you're insolvent (owe more than your assets) or it was a farm debt, it might not be counted as income either. If you don't need to report the amount on the 1099-C as income, the IRS says you need to file a Form 982 to tell them, when you file your regular taxes.
So that's the story about debt settlement and being reported to the IRS. It's not nearly as bad as it sounds, though it might mean you need to pay a little in taxes.
11:15 p.m. February 26
What about state taxes?
11:26 p.m. February 26
Varies by state. Search for canceled debts or debt forgiveness and your state's name and taxes to see.
8:21 a.m. February 27
I paid $4750.00 to a debt settlement company that was supposed to settle my credit cards and make an offer of comprimise with the IRS and after 19 mos. of paying I have nothing to show for it. They took the money each month and said to stop paying our bills and send the debt collectors to them but they weren't forwarding the money and then after 19 mos. I find out there is a lean on me from the IRS and when I tried to call them there was no answer, they had went out of business. I'm filing criminal charges with the sheriff and iniated a suit against them.
10:15 a.m. February 27
Um, okay. Sounds like you got mixed up with a bad debt management plan run by a bunch of crooks. It's a Catch 22, because it's hard to deal with the IRS directly because of all the complicated laws, but it's hard to find a company you can really trust. Hopefully you can find a good lawyer who'll explain to the IRS and your lenders that you were being swindled and it wasn't your fault your money wasn't being forwarded to them (if that's what was going on). Or you can try explaining the same thing yourself. A criminal complaint or evidence of a lawsuit would help convince them, I'd think, and hopefully they'll be lenient.
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