So it’s tax season time again. After the end of January, everyone gets their tax papers and receipts together and attempts to get their tax refunds. And so also, anyone who has defaulted in any debt in the last year needs to watch out for some traps.
The first is the concept of ‘charge-off‘. Street knowledge tells us that it menas that you no longer owe the debt. The creditor has charged it off and now nothing is owed. Dead wrong. Charge-off is the process that a creditor takes after making a concerted effort to collect a debt. The end result is a removal from the creditor’s books as an asset and a resulting tax deduction from the creditor’s income taxes.
While that is all fine, you can see that there is nothing in that process that forgives the debt and somehow closes the matter once and for all. No, what that means is a ‘charge-off’ will be reported to the credit bureaus creating a negative effect on your credit rating. The second is that the creditor is now free to issue a Form 1099 to you indicating that you have not paid the debt and therefore you have now received ‘income’ from the process for the purposes of tax reporting. It is not real income; it is commonly referred to as phantom income because no real money has changed hands. Instead, you received the benefit of the credit when you did receive real money or goods by placing a charge on the account and now the creditor is shifting the income benefit to you.
Receiving a 1099 form means you have to add the amount to your tax return as income thereby increasing the amount of taxes you will pay or reducing the amount of your tax refund. There is a way around it by filing a companion Form 982 with your taxes if your liabilities still exceed your assets. Go back and re-read my post on determining your asset picture. If you are negative, then filling out the Form 982 will reverse that Form 1099.
Meanwhile, you STILL owe the debt. Typically, creditor will then sell your account off to a debt buyer who specializes in buying bad accounts and then collecting on them. So now, not only do you have the problem of getting your tax return straightened out so you can get your tax refund, you now have to deal with the incessant phone calls and letters from collectors attempting to collect that debt that your thought was ‘forgiven’.
If the Form 982 doesn’t help you with your taxes or you can’t deal with the phone calls, you can always explore the options of filing for bankruptcy. Oh, and if you pay those charged off debts later, the debt buyers will pay taxes on the income, but you won’t get your lost tax refund back.