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Dear Liz: My husband racked up more than $17,000 in credit card debt and negotiated a settlement for $4,000 last year. We received a 1099-C form for $13,000 of forgiven debt, which we have to claim as income. That puts our modified adjusted gross income over the threshold of being able to claim tuition and college expense deductions for our three kids and myself. We now owe more than $11,000 in taxes and we don’t have the cash to pay. Any advice would be greatly appreciated.

Answer: You may think owing an $11,000 tax bill because you saved $13,000 on a credit bill is bad enough. But the ironies just keep coming.

For many people, the best way to pay an IRS bill when they don’t have the cash is often by credit card or a bank loan such as a home equity line of credit. As the IRS puts it, “The interest rate and any applicable fees charged by a bank or credit card are usually lower than the combination of interest and penalties imposed by the Internal Revenue Code.”

Given your situation, though, you may not have access to a low-rate loan. If not, you’ll need to work something out with the IRS.

If you owe less than $25,000, you can file online for a short-term (120 days) extension or a longer-term installment plan. The IRS penalty for nonpayment is 0.5% a month and the interest rate is 4% a year, or a combined rate of around 10% a year. There is a one-time fee of $105 for installment agreements, although that can be lowered to $52 if you agree to a direct debit from your checking account.

You’ll find more information at http://www.irs.gov/taxtopics/tc202.html.

Whatever you do, don’t use this problem as an excuse not to file your tax return, since the failure-to-file penalty (5% a month) is 10 times as much as the failure-to-pay penalty.

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Categories : Credit Cards, Q&A, Taxes

2 Comments

1

This is the first I’ve heard about forgiven debt becoming “income.” I owe a lawyer and we’re in dispute about how much. You’re saying whatever I get him to “forgive” I actually have to pay taxes for that? If so, this is truly money from nothing. Please explain further. Thanks!

2

When you’re contesting your liability for a debt, it’s typically not counted as forgiven debt and income to you. It’s when you negotiate a settlement for a debt you’ve already incurred that this becomes an issue. Check with a tax pro to make sure, though.