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Use Tax Refund For Debt Settlement?

Debt settlement is a great tool for getting out of debt, and it hits all of the right buttons:

You get out of debt at a discount!
You save money while getting out of debt!
You get out of debt without filing bankruptcy!

You go long enough without having made a payment on your credit card, and your credit card company may send you a letter offering to accept a discounted payment as a payment in full. Perhaps your tax refund will provide you enough money to do that on one of your debts.

My view on this option, and all others, is this: If you can’t see yourself going all the way down a certain road, then why take even one step in that direction?

First thing to consider is the income tax effect. When you settle a debt for less than what you owe, the creditor is cancelling that portion of the debt that you are not paying. That portion of the debt that is cancelled is treated as tax income, and it must be included on your tax return. The creditor will send you an IRS Form 1099-C for cancellation of debt. So, make sure you can pay the taxes on the debt settlement.

Next, what are you going to do with all of your other debts? If the tax refund is the extent of your savings, and you are living paycheck-to-paycheck, then what are you going to do if you get sued on an old credit card debt?

Instead of using your tax refund to take care of one of your debts, you may want to use it to file bankruptcy to get rid of all of your debts.

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