Legally reviewed by Allen A. Kolber, Esq. - The Law Offices of Allen A. Kolber, Esq., P.C.
Key Takeaways
- Debt forgiven in a settlement is generally taxable income to you, while debt discharged in bankruptcy is not.
- A trustee can reach payments you made to a single creditor in the 90 days before you file.
- A for-profit settlement company cannot charge you a fee before it has actually settled a debt.
Initially, declaring bankruptcy may have seemed too daunting, so you entered a debt settlement plan instead. But since this decision, your financial circumstances may have changed once again, sadly for the worse. Now, you may worry that bankruptcy would have been the better choice to offer you the financial relief you desperately need. Well, if this thought is sitting heavy with you, please follow along to find out whether it is best to file for bankruptcy in the middle of your debt settlement and how a proficient Rockland County bankruptcy attorney at The Law Offices of Allen A. Kolber, Esq., P.C., can help you navigate this tricky and financially delicate situation.
What Is the Difference Between Debt Settlement and Bankruptcy?
First of all, you must understand the implications behind debt settlement and bankruptcy before you choose either path. In simple terms, debt settlement is when you negotiate a deal with your outstanding creditors, typically to reduce the lump sum amount you owe them. This may be handled through a third-party debt relief company, and therefore, it is an out-of-court procedure. And with that, your outstanding creditors are not legally required to negotiate an agreement with you. Worst case, they may respond to this plea by filing a lawsuit to collect the debt.
Then, as you may have assumed, bankruptcy is a formal legal procedure supervised by the federal court.
During Chapter 7 bankruptcy, a court-appointed trustee can sell any non-exempt assets as a means of paying your creditors, while any property that is protected by an exemption will remain yours.
And in a Chapter 13 bankruptcy, you may follow a court-ordered repayment plan for your outstanding creditors. Here, your creditors do not have to give their approval before you file your bankruptcy petition. However, they may actively participate in the process, such as filing motions to lift the automatic stay or rejecting a proposed repayment plan.
Is It Wise to File for Bankruptcy if I’m Already in Debt Settlement?
As you now understand, debt settlement and bankruptcy are two totally separate processes. You may initiate these processes at any time. Notably, you may be allowed to file for bankruptcy even after negotiating a debt settlement agreement with your outstanding creditors. Upon submitting your bankruptcy petition, your existing settlement agreements may be overridden.
However, you cannot get back the debts you already paid and settled in these agreements thus far. Meaning, these debts may not be made dischargeable at the end of your bankruptcy proceedings.
With that said, at this time, the third-party debt relief company you are working with may be legally obligated to stop collecting or distributing payments for debts included in your bankruptcy case. You may need to formally cancel your contract with the company to ensure further withdrawals do not occur. Unfortunately, you may not get a refund for the advance fees you paid to the company, especially if they were not held in trust. Rest assured, this is something your attorney can help you sort out.
Do I Pay Taxes on Settled Debts?
When a creditor forgives a portion of the debt you’ve accumulated, the forgiven balance is typically treated as ordinary income, and the creditor may report it to the IRS via Form 1099-C. Debt wiped out during bankruptcy is treated differently. The IRS excludes debt canceled in a title 11 bankruptcy case from your income entirely, regardless of whether you filed Chapter 7, 11, or 13. Outside of bankruptcy, a separate exclusion may be applicable if your debts exceed the value of everything you owned immediately before the cancellation, though it only shields you up to the amount you were insolvent.
Regardless, either exclusion must be claimed on Form 982, as this is not assumed.
What Happens to the Settlement Payments Already Made?
Money that you have already paid towards debt is gone from your side of the ledger, though it may not be done moving. A trustee holds avoiding powers that can reach payments made to a creditor in the 90 days before filing, and pull that money into your bankruptcy estate, where it is shared with all creditors, not just the one you settled with.
For filers who primarily have consumer debts, transfers totaling under $600 fall outside of that reach. The timing of a lump-sum settlement payment is generally worth reviewing before filing.
What Does New York Law Say About the Debt Relief Company You Hired?
Before writing off the fees paid, you should first find out what the company was allowed to charge. Under the Federal Trade Commission’s Telemarketing Sales Rule, a for-profit debt relief provider that sells by phone cannot collect a fee until it has settled or reduced one of your enrolled debts and you have made a payment under that agreement.
If it requires you to fund a dedicated account, that account must sit at an insured institution, the money in it stays yours, and your unearned fees and savings come back to you within seven business days of leaving the program. New York adds a layer: state law bars the business of budget planning unless the provider is licensed under Article 12-C of the Banking Law, and that definition excludes attorneys admitted here and licensed not-for-profit planners.
Contact an Experienced Rockland County Bankruptcy Attorney Today
To conclude, when it comes to your bankruptcy case, you should not settle for anything less than spectacular legal representation. So please hire us to help with your bankruptcy proceedings. A talented Rockland County bankruptcy attorney from The Law Offices of Allen A. Kolber, Esq., P.C., looks forward to working with you.
