Did you recently hear about Bill Gates, the former President & CEO of Microsoft, one of the richest men in the world? He decided to give away all his shares of Microsoft and start working at a local car wash in Seattle, Washington area. When being interviewed on a local television station as to why he decided to do it, Gates admitted that he was losing too much money on taxes. You see—by making $8 an hour he explained, he would be in the lowest tax bracket of anyone in the nation, and if he could manage to make less than $19,000 a year, then he would not have to pay any taxes at all! Back when he was making a $1 billion annually, he was left with $500 million after taxes every year. So Gates thinks he can make more money this way, hence the term debt settlement and taxes.
As preposterous as the above example sounds, this is exactly the same logic employed by consumers who fear the tax implications when dealing with a debt settlement company. For one, most people enrolled in debt negotiation program do not have to pay taxes on their savings (forgiven debt) which we will explain in a minute. Secondly, why in the world would it even cause you to think their may be ” an issue” with this when contemplating a debt settlement program anyway? It’s literally the equivalent of someone turning down a million dollar salary for minimum wages because of the favorable tax implications.
Consider the following scenario.
John B. owes ABC credit card company $20,000. His current interest rate was at 19% when he enrolled in our debt settlement program. When our negotiators settled John’s debt for him, John was able to reduce his debt down by 45% and in the process he saved $9000 off the balance alone! Unfortunately, ABC credit card company reported John’s savings to the IRS and he was told he would have to pay tax on this $9000 or “forgiven debt.” John currently earns $40,000 in annual income as a school teacher. Therefore, John was looking at paying tax now on $49,000 versus $40,000, which put him in the 30% tax bracket and also meant he would have to had to come up with $2700 on April 15th. Regrettably, John did not have the money, so he got on a payment plan with the IRS, who charged him their current interest rate, which happens to be 8 percent annually. In the end, John paid off the IRS in 1 year for $2916. This means that John in actuality only saved approximately $6,000 off the his original balance versus $9,000.
So would John have been better off continuing to pay the minimum monthly payment on his ABC credit card instead of settling his debts? Let’s see. He saved $6,000 off the balance alone and roughly $40,000 in interest charges, which brings his net savings to $46,000. It’s pretty clear that it was still in John’s best interests financially to enter the debt settlement program.
However, it does not end here. Most debt settlement candidates ever have to pay taxes on “forgiven” debt anyway. The IRS has a law that exempts anyone who was technically insolvent at the time their debt was settled from having to pay taxes on the savings. So the next question is, what does it mean to be insolvent? According the IRS, someone is insolvent when their assets (what you own) exceeds their liabilities (what you owe). It should then come as no surprise to any of our clients that when someone is at this point in their life when they are contemplating seeking debt relief, they’re probably in debt up to their eye balls anyway and therefore are insolvent.
If you owe more than the value of your assets, then all you have to do is fill out IRS form 982 along with your tax return illustrating this fact. All told it will probably take you a couple hours to do this, and if you saved $46,000 like John in our example, then it’s the equivalent of making $23,000 an hour. In the 12 years of being in business, we have only had one client whose assets were higher than their liabilities, and that was because their family owned farm shares left to them from a deceased relative. Therefore, unless you are Bill Gates, it’s probably worth it.