Credit Card Quick

What you need to Know about Forgiven Debt

Credit Card Debt

You may have heard of it before: a credit card customer, bogged down in credit card debt, cuts a deal with their creditor to have some of their debt forgiven, in exchange for paying off the remainder of the debt and closing the account. Sounds good, right?

Is all Really Forgiven?

Well, not so fast. Forgiven debt is not really forgiven, in the eyes of the creditor or the IRS. In other words, when a creditor forgives some of your debt, that debt is then reported to the IRS as taxable income.

Although credit card companies are facing hard times for several reasons, including the tough economic conditions and the pending credit card laws, they recognize that tough times call for tough measures. In other words, something is better than nothing, even when it comes to collecting credit card debt.

If a credit card customer has limited resources, and the credit card company chooses not to cut a deal with the customer to resolve a credit card balance, then chances are they will not receive anything.  Faced with that fact, many creditors are now forgiving debt so that they can collect at least part of the customer’s debt.

As it stands now, credit card companies have written off nearly $275 in unpaid credit cards over the past five years.

Is Debt Forgiveness for you?

Although accepting a “forgiveness loan” from your creditor may seem like your best option, be aware that any portion of your balance that is written off will be reported to the IRS and declared as income. Credit card companies are legally bound to report any forgiven debt to the IRS, which could make things difficult for you at tax time.

For example, if you have a $10,000 credit card balance and the creditor has agreed to forgive $5,000 of that balance, you will then need to pay taxes on that $5,000 come tax time.

There are a couple exceptions to this rule: the income does not need to be reported to the IRS if the amount of forgiven debt is less than $600; or your debt has been written off by the credit card company as “unpayable,” meaning that the debt has been forwarded over to a collection agency for payment.

How Many Credit Cards do you Really Need?

Choosing Credit Card

We hear conflicting opinions all the time regarding the number of credit cards we should have, must have, and never exceed. But what is the magic number?

Well, for starters, there is no magic number, and what works for you in terms of the number of credit cards may very well not work for another individual. There are, however, a few points to remember when considering your perfect number of credit cards:

• Pay close attention to your debt-to-income ratio. If you have a card with a balance that exceeds 50 percent of your credit limit, then you may be entering into dangerous territory because many creditors may perceive you to be a credit risk. However, if you exceed 50 percent of the credit limit on one of your cards, it may not be such a big deal, credit-wise, if you have another card or two with low balances, as this will decrease your debt-to-income ratio.
• Consider holding at least two credit cards if you feel comfortable that you can effectively and responsible manage the two cards. However, if you tend to spend on your credit cards then a second credit card may not be the right decision for you. Again, this is where “one sizes fits all” does not apply.
• Don’t hold so many credit cards that you have difficulty managing them. In other words, if you have 10 cards, all with low balances, then you are ahead of the game. However, if these 10 cards create confusion when it comes time to paying them, then they certainly are not worth the hassle, even if you have a fantastic income-to-debt ratio as a result. If you are unable to effectively manage your cards then chances are you will miss due dates and payments, thereby negatively affecting your credit score.
• Be careful about closing credit card accounts, as this may negatively affect your credit score; specifically, your income-to-debt ratio.
• Consider choosing major credit cards (Visa, Master Card, Discover and American Express) over department store credit cards, as major credit cards typically have higher credit limits (which have a positive effect on your income-to-debt ratio) and lower interest rates.