Maxine Aaronson, Attorney at Law
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Tax Newsletter

  • Life Insurance Proceeds & Taxes
    A common misconception about life insurance is that it is “tax-free.” While the build up in cash value of a life insurance policy is typically not subject to any income tax, the death benefit payable on the policy may be... Read more.
  • Innocent Spouse Relief For Tax Liability
    Many married couples file joint tax returns to take advantage of certain benefits offered by this filing status. This may result in the unfortunate and unintended consequence of one spouse being held responsible for the underreporting... Read more.
  • Structured Settlements
    There are numerous legal situations in which a person may receive a large sum of money through a court award or settlement. Often arising as compensation for personal injuries or other acts, most such payouts are reduced due to some or... Read more.
  • Valuation of Estate Assets for Tax Purposes
    Assets owned by a person at the time of their death, whether real or personal property, is commonly referred to as the decedent’s “estate.” After the person dies, the property or proceeds from the sale of such property... Read more.
Tax News Links

Income from Debt Cancellation

When you obtain bankruptcy relief, you are essentially receiving a financial benefit, because most, if not all, of your debts will be wiped away. The tax consequences of debt relief differ greatly depending upon whether the debt is discharged through bankruptcy or settled outside of bankruptcy.

Settlements Out of Bankruptcy

The Internal Revenue Service recognizes the financial benefit where debts are settled outside of bankruptcy, and generally considers any financial benefit as taxable income.

For example, if you settled a $5,000 credit card debt for $2,000, you must pay income tax on the $3,000 you saved pursuant to the settlement. The creditor will most likely report this settlement to the IRS, and will also send appropriate tax documents to you.

Discharged Debts

However, if a debt is discharged in bankruptcy, the IRS makes an exception to the general rule and does not consider it taxable income.

The tax considerations of negotiating a debt outside of bankruptcy must be weighed against the consequences of a bankruptcy.

Simply avoiding a bankruptcy by settling accounts with creditors might not be the better option, particularly if all debts will be dischargeable through bankruptcy anyway.