There are many reasons why bankruptcy may be a better solution to overwhelming debts than debt settlement. And here's another one: tax savings.
Millions of Americans unable to pay credit card debt and other large debts turn to debt settlement each year. But while creditors may agree to discount your debt, that doesn't mean you've seen the end of it.
Consumer debts that are forgiven through debt settlement are considered to be taxable income by the IRS if the savings is over $600, according to Today.
That means that if you negotiate to settle a $20,000 credit card debt for $10,000, you would owe taxes on the forgiven $10,000 come April. If you're in the 15 percent tax bracket, that comes out to $1500.
Of course, because consumers don't see any cash from the settlement, many don't realize they need to report their savings - resulting in costly audits and fees in addition to their tax bill.
Some credit counselors and debt settlement companies fail to explain this tax liability to consumers because they want to make the debt settlement process sound more appealing than it actually is.
There's only one way to make debts disappear for good. Debts discharged through bankruptcy are exempt from taxes, so you won't have to worry about the IRS knocking on your door. Or harassing bill collectors, for that matter.
Chapter 13 bankruptcy is ideal for homeowners who have a reliable income source but simply can't afford to keep up on debt payments. Chapter 13 allows the consumer to spread out debt payments over a period of three to five years, during which time their home is protected from foreclosure. Debts remaining after that period are typically forgiven - and non-taxable.
For those without major assets or on a limited income, Chapter 7 bankruptcy offers an even faster solution. With Chapter 7, it's often possible to completely eliminate unsecured debts like credit card debt, payday loans and medical bills in just months.
When debts have snowballed out of control, bankruptcy can be the most effective - and affordable - way to rein them in.