You have most likely received offers from “debt counselors” at one time or another promising to consolidate your debt, reduce your interest rates or negotiate settlements with your creditors. BEWARE. While there are reputable credit counseling organizations that do have your best interests in mind, most of the offers you get will likely come from someone more concerned about profiting from your situation.
Let’s look at a recent case we had where one of our clients hired a “debt reduction” agency prior to coming to us to represent them. The chart below is a reproduction of the actual plan summary given to our client that details the plan for reducing the client’s debt. The names of our client and the agency have been removed in the interest of privacy.
Estimated Personal Savings Plan
|20,798.89||3 Initial |
|595.80||Savings Budge |
|1,787.40||Minimum Savings |
During 21 Remaining
Service Fee Payments:
|Total Debt |
|6,012.18||Minimum Personal |
After Agency Fee
|Total Debt Savings:||23,398.76||21 Monthly Service |
Fee Payments of:
|286.29||Total Payments |
After All Payments:
|595.80||Total Months |
Now more bad news. When a creditor “forgives” a debt that you owe, the amount of the debt that is forgiven is considered income to you on which, with some exceptions, you must pay taxes. That’s right. You must pay taxes on money you never receive. This is referred to as “income from the discharge of indebtedness,” and it may actually be more difficult for you to handle than the original credit card debt. Why? Keep reading.
When you owe money to credit card companies, it is rare that they will file a lawsuit against you to collect. They will badger you constantly, but it is rare for them to actually pursue collection action in court. The IRS is not so lenient. When you owe tax to the IRS, you will eventually get a Notice of Deficiency from them telling you how much tax you owe. If you ignore the Notice of Deficiency, eventually the IRS will place a lien against your property. If you ignore the liens, the final step will be a levy, where the IRS can seize your property and garnish your wages.
Let’s use the numbers from the chart above to see what would happen to the Client. The chart shows that the debt savings to the Client will be $23,398.76. After agreeing to settle the debt with the Client after 2 years, the credit card company will send the Client Form 1099 showing income to the Client of $23,298.76. Assuming the Client is in the 25% tax bracket, the Client will have to pay an additional $5,824.69 in taxes. And if the Client can’t pay the tax? Don’t bother telling the IRS. The Client will likely have to enter into a 5 year repayment plan on top of the plan he or she already entered into with the credit card company.
So after taxes, what was the real debt elimination cost?
Settlement Amount $20,798.99
Agency Service Fee $7,799.58
The RESULT: the Agency only saves the person 34% of its total debt (not the 60% savings it would have you believe), the Client must spend 2 years ignoring collection calls, another 2 – 3 years paying the remaining debt agreed to in the settlement, possibly 5 years paying the tax due on the debt forgiveness, and on top of everything else, the Client’s credit is still ruined.
If you aren’t capable of repaying all of your debt, but you either don’t want to file for Chapter 7 bankruptcy or don’t qualify, Chapter 13 provides a much cheaper, more reliable repayment-plan alternative. You can think of Chapter 13 bankruptcy as court-supervised debt consolidation and reduction, and your creditors will be required to go along with the plan.
The following are some of the benefits Chapter 13 bankruptcy presents that typical debt reduction plans don’t:
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