Dear Liz: I understand that creditors eventually write off unpaid debts and receive a federal tax deduction for the loss. Then they sell that “debt” to a collection agency. However, isn’t the debt rendered void by the fact the original creditor charged it off and got the deduction? So how can collection agencies attempt to collect an invalid debt?
Answer: Charging off a debt and taking the tax deduction for the loss indicates the original creditor doesn’t believe it can collect the money. That doesn’t render the debt invalid or erase it in a legal sense. Debts typically exist until they are paid, settled or wiped out in Bankruptcy Court.
The questioner is being confused by the jargon (“write off’) used to describe the process. A debt is just an IOU, and if a creditor sells an IOU, that just means the debtor now owes the money to the new owner.
The loss the original creditor has is the amount loaned minus what the debt was sold for. That loss is entered as a deduction on the creditor’s income tax return, which reduces the creditor’s net income, and that results in a reduction in the creditor’s income tax bill by an amount that depends on the creditor’s tax bracket.
The creditor does not take a loss for, or get a tax deduction for, uncollected interest on the loan. The creditor does report, and pay income tax on, collected interest.
The collection agency that bought the loan will have a loss or a gain if it collects less or more than what it paid for the debt.
The creditor, aka Banks, are paid back that loan 5x over with the high interest rates, over limit fees, yearly member fee, late fees. As for their tax write offs, what tax? Most of their profits are not taxed. There sent overseas in tax havens. That goes for the CEO and upper management while we the working class are taxed to death. Oh and one more sneaky, underhanded action of the financial sector. Reporting your debt to the IRS as income. As I experienced, but I fought and won. I know of no income where interest and fees are attached to it. Debt is not income.
Debt is not income but relief from debt is, at least according to current IRS code. That’s a whammy a lot of people who settle debt don’t see coming.
Relief from debt is real income. When you get a loan, you receive money in exchange for your IOU. If the bank forgives the loan, they have essentially given you an amount of money equal to the balance you owe.