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I fell behind on five credit cards. Is it better to settle the debt all in one year or over two years?

Sep 28, 2018, 09:29 AM by Lesley F. Katz, CPA
Answer from the free Ask a CPA service on whether it's better to settle credit card debt in one year or over 2 or more years if one is behind on several credit cards.

I had a plumbing disaster this year, and I fell behind on five credit cards. Then I had to evict a tenant. So, my income has changed. My income properties are an S corporation. I will have to settle my debt. Is it better to settle all of them in the same year or straddle them over two years? I'm afraid I may owe on the 1099 income from the creditors.

Credit card debt is the most common form of debt. The best way to address paying down debt is to pay at least the minimum amount due each month on each credit card. This prevents your credit rating from being negatively affected. If there is extra money available each month, then extra money should be applied to the credit card with the highest interest rate (pay less for the money borrowed) and/or the lowest balance credit card (feeling of accomplishment).  

If the debt holder wishes to negotiate with the credit card companies and settle some of the debt (principle and interest), the credit card companies oftentimes will forgive a portion of the amounts due. When this happens, a 1099-C is issued to the account holder at year end. This 1099-C also is sent to the taxing authorities (IRS and state) and is considered income to the taxpayer.   

The choice to have debt forgiveness for all five credit cards in one year is one that you and your accountant should review together. If you have losses that can offset additional debt forgiveness income that is substantial enough to reduce the tax, then addressing more or all in one year may make sense. If there are no offsetting losses, and the amount of tax owed on the debt forgiveness income may be too high to pay in one year, so it may make sense to straddle two or even three years. However, balances due on credit cards not settled should have minimum balances paid to preserve your credit scores.  

There are some exclusions of cancelled debt from income, but based on the information supplied above, it does not seem to apply. There are many variables and facts that can impact a decision to settle debt and the time frames within which this is done. I recommend consultation with a tax professional.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Lesley F. Katz, CPA, is the founder of Leveraging Financial Knowledge LLC in Lower Gwynedd, Pa.