There are many reasons one would consider filing for bankruptcy before seeking partial loan forgiveness from a creditor. As an example, when debts are discharged within a bankruptcy proceeding, it is considered a non-taxable event, while non-bankruptcy loan forgiveness is considered taxable.
Let’s assume that you owe $20,000 to a credit card company. Although you cannot pay the full balance, you can pay a $5,000 lump sum. Even if you were to reach an agreement with the creditor to accept the $5,000 lump sum and to forgive the remaining $15,000, the creditor would be required by law to send you a 1099-C Form which states that $15,000 of the $20,000 was forgiven. You must then report the $15,000 as income on your federal and state income tax returns. Assuming that you pay a combined state and federal income tax rate of 25%, you would owe $3,750. Speaking from the perspective of the IRS, your income was increased by $20,000 by the creditor who only received $5,000 back. Therefore, the $15,000 is still considered part of your income. On the other hand, if you were to file for bankruptcy and receive a discharge of the $20,000 credit card debt, the discharge would not be taxed. For this reason alone, filing for bankruptcy instead of obtaining loan forgiveness directly from a creditor may be more beneficial to you. If you find yourself in this position, you should call Winegar, Wilhelm, Glynn & Roemersma, P.C. where experienced bankruptcy attorneys can assist you.
Scott M. Wilhelm, Esq.
THIS IS A GENERAL DISCUSSION OF LAW AND IS NOT INTENDED TO BE LEGAL ADVICE. FOR ANY LEGAL QUESTIONS PLEASE CONTACT OUR OFFICE AND SPEAK TO AN ATTORNEY.