You’ve got too much debt to ever pay off. What can you do? Some people facing gargantuan debt don’t want to avail themselves of bankruptcy, the most effective way of dealing with debt, and instead hire a debt settlement company to negotiate with their creditors. The following exchange appeared in Liz Weston’s March 13, 2016 column in the L.A. Times (emphasis added):
Dear Liz: My wife and I owe about $46,000 in credit card debt. We are considering a debt consolidation plan in which our debt would be reduced to about $27,000. According to what I’ve read and what’s included in the paperwork, any reduction in our debt may be reported to the IRS as income. I’m assuming this would not only increase our tax burden but could result in the forfeiture of some of my Social Security benefits. Am I correct in these assumptions?
Answer: What you’re considering is debt settlement, not debt consolidation. With debt consolidation, you get one loan to pay off other, smaller debts in full. The right debt consolidation loan would offer a fixed interest rate and would allow you to pay off what you owe within three to five years. Debt settlement, on the other hand, means you’re trying to get your creditors to accept less than what you owe. Debt settlement typically requires that you stop making payments to your creditors, which will trash your credit scores and could lead to lawsuits. You typically accrue interest, late fees and penalties that could offset or even wipe out any savings the debt-settlement company is promising you. And the fact that the company seems to be promising you specific results, such as a $19,000 reduction in your debt, is a red flag all on its own. Your creditors don’t have any obligation to settle with you, and a debt settlement company shouldn’t promise that it can make the debt disappear. To answer your specific questions: Yes, any debt that is “forgiven” in a settlement is considered income that can be taxed. It isn’t considered earned income, however, and so doesn’t trigger the Social Security earnings test that can reduce your benefits. You’d be wise to read what the Federal Trade Commission and the Consumer Financial Protection Bureau have to say about debt settlement on their sites. In the vast majority of cases, you’re better off avoiding this option. Pay off what you owe if you can. If you can’t, explore a debt management plan offered by a nonprofit credit counselor and also make an appointment with a bankruptcy attorney so you understand all your options.
Brava Liz! (Brava is the feminine of bravo.) Exactly how will a debt settlement company be able to force a creditor to reduce a debt from $46,000 to $27,000? What power do they have over the creditor? Answer: none; not even the Vulcan death grip.
Occasionally I come across stories of debt settlement companies that reinforce my opinion of them. A recent one involved an entity that had fleeced one of my clients. Over an eighteen month period my client paid them almost $9,000 for debt settlement services. Then one of the creditors filed suit against my client. At that point my client hired me to do a bankruptcy. The bankruptcy was successful, and my client emerged debt-free.
The Connecticut Department of Banking (“CDB”) ruled against the owner of, and only attorney associated with, that entity. The CDB prohibited him and his company from providing debt negotiation services in Connecticut, fined them $25,000, and ordered them to refund the scammed people for perpetrating in Connecticut the same sort of scam he used against my client.
One of the many reasons that bankruptcy exists is that, unlike debt settlement, it really works. When you file for bankruptcy protection you have the power of the United States Government behind you to force your creditors to accept the terms of the bankruptcy. That may mean that your debts are wiped out in a Chapter 7 bankruptcy without you paying anything; or it might mean that you pay something to your creditors in a Chapter 13 plan. And once the judge confirms the plan, your creditors have to accept its terms because of 11 U.S.C. § 1327(a):
The provisions of a confirmed plan bind the debtor and each creditor, whether or not the claim of such creditor is provided for by the plan, and whether or not such creditor has objected to, has accepted, or has rejected the plan.
If you are a debtor in the Central District of California, and want to get debt relief, don’t spin your wheels with a debt settlement company. Instead, contact an extremely knowledgeable and highly skilled bankruptcy attorney to get you the bankruptcy relief to which you are entitled under article I, §8, cl. 4 of the U.S. Constitution, and mandated by God in Deut. 15: 1-2:
At the end of every seven years you shall grant a release of debts. And this is the form of the release: Every creditor who has lent anything to his neighbor shall release it; he shall not require it of his neighbor or his brother, because it is called the Lord’s release.