Simply put, if a cancellation of debt does not make an insolvent taxpayer solvent, then the amount of debt forgiven is, most often, not taxable income to the taxpayer.
An understanding of the tax provisions regarding insolvency and cancellation of debt, concurrent with a burdensome outstanding student loan balance and/or upside-down vehicle loan, can benefit anyone seeking to restructure their finances. The student loan is an unsecured debt. The consumer has no asset to directly offset the debt when calculating net worth. The student loan, while not forgivable, is part of a program that offers many options for stretching out the payments, thereby creating resources to negotiate settlements on other debts.
The consumer-oriented collection procedures for student loans include, without limitation, various reduced payment and forbearance options. If wisely selected, these can be helpful in getting the balance of one's monthly payments for bills reach a manageable level. At that point, an individual may be able to increase the level of monthly payments to be applied toward the student loan debt.
Identify Debts to Negotiate Settlements On
An individual should pull together all the pieces of his or her budget. Line up the debts, separate them by secured and unsecured debts. List the balances owing, the interest rates and the minimum monthly payments. Identify which debts need to be paid first (such as the mortgage payment and car payment) and which ones might be candidates for debt settlement options.
The individual should next list his or her assets, the original purchase price of the assets and the fair market value (what a willing buyer would pay for them) as of the current date.
Text the Tax Consequences of a Proposed Cancellation of Debt
When this is done, the individual should do "what if" scenarios for payment settlements on each debt, calculating the tax consequences of various debt settlements. If secured debt is involved, further information should be reviewed as found on the IRS website or through consultation with a tax professional.
The Timing of a Cancellation of Debt
The objective here is to achieve a positive net worth and an ability to pay off one's student loan debt. Minimizing income taxes along the way will reduce the amount of time it takes to achieve that positive net worth. In other words, the funds not paid toward income tax would be, theoretically, available to apply toward other debt, as well as the student loan debt. The timing of knowing when to settle which debt and for how much is critical to this process. Each consumer needs to make these decisions for himself or herself.
Speeding Up Achieving a Positive Net Worth
With the season for the best settlement offers approaching (the winter months of every year), a consumer burdened with debt that includes a student loan and/or an upside-down car loan, now is a good time to start the analyzing process described above. Structuring debt settlements to minimize personal income taxes on the amounts of debt forgiven can contribute to a speedier payoff of a student loan.
