Debt Relief

Debt Relief: Understand Taxes, Credit Score Impact, and Lawsuit Likelihood in 2023

Written by Ben Tejes
Updated Aug 23rd, 2023
Debt relief can be an effective way to help you get out of debt when that debt becomes unaffordable. There are 4 main types of debt relief including Chapter 7 bankruptcy, Chapter 13 bankruptcy, debt settlement and debt management. For the purpose of this article, we will spend the most time focusing on debt settlement as that is the most common option. That said, we wrote extensive articles covering Chapter 7 bankruptcy, Chapter 13 bankruptcy and debt management if that's what you are most interested in.

With debt relief, it is VITAL that you understand the fees associated. Debt relief also has pros and cons you should consider. For example, a payday loan offers cash for an immediate need, but the interest rate is often debilitating. It can lead one down the cycle where it feels that you are robbing Peter to pay Paul.

The purpose of this article is to answer ALL of your questions related to debt settlement.
  1. Debt Relief process
  2. Debt Relief pros and cons
  3. Credit score Impact of Debt Relief
  4. Debt Relief potential tax consequences
  5. Alternatives to Debt Relief
  6. Debt Relief common questions
  7. Is Debt Relief best for you?
Before we get into the nuts and bolts, let’s talk about the affordability of debt settlement and costs. You can take the free debt settlement calculator below to estimate your debt settlement payment, see pros and cons, and check alternatives that are unique to YOUR situation.


What is Debt Relief?

Debt Relief is an individual or service working on an individual’s behalf to negotiate your debts lower than what is owed. Debt settlement is for an individual who is unable to afford his/her debt.

There It is a specific option among a variety of options that cover the severity spectrum.


Debt Relief Process:

Debt settlement companies work as an intermediary between the individual owing the debt and the creditor. The debt settlement company will do the following for the enrolled participant:
  1. Create an enrollee-owned escrow bank account for the enrollee where all of the funds are aggregated.
  2. Consolidate all of all the payments to creditors into one payment.
  3. Act as the primary contact between the creditors, preventing future collection calls.
  4. Negotiate on behalf of the enrollee for less than owed based on financial hardship.
  5. Receive permission from the enrollee on whether to accept the settlement and payment plan.
  6. Manage and send all of the payments to the creditors until the debt has been paid for and is resolved.
A couple points to note:
  1. Understand the fees charges and compare those fees against other debt settlement company fees. Companies charge different amounts for a similar service, so do your homework to get the best rate. 
  2. Understand how the program works and who you work with after the program starts. Some programs have personal finance advisors and others send you to customer service after the sales is made.
Some debt settlement entities work to get accredited, but when Ascend practiced debt relief, we decided not to be BBB accredited per Ascend's direction at the time.

Debt Relief Pros and Cons:

The extensive list of Debt Settlement pros and cons below is from perceived highest importance to lowest importance:

Debt Settlement ProsExplanationImportance
SavingsYou often pay less than owed. The savings vary by creditor, but the savings can be 50% or higher.High
Payment FlexibilityYou have more flexibility to set the amount for your escrow account each month than a bankruptcy or a loan.High
TimeDebt settlement programs can produce debt freedom much faster than making minimum payments or pursuing a consolidation loan.Medium
Avoid BankruptcyDebt settlement can be a great alternative to bankruptcy in certain situations.Medium
Financing FlexibilityYou may have access to credit or. a loan faster with debt settlement than bankruptcy.Medium
AccountabilityCanceling your credit cards in debt settlement can act as accountability.Low

Debt Relief Cons:


Debt Settlement ConsExplanationImportance
Credit Score and Credit ReportYour credit score will often be negatively impacted during the program, so the question is whether getting out of debt is more important than your temporary credit score. Your credit report will also show that you settled your debt which can have adverse effects.High
Creditor LawsuitCreditors may file a lawsuit.High
Late Fees and InterestThe debt owed at negotiation is often higher, so negotiations are on a higher amount.Medium
Creditor May Not Work With YouCreditors may not accept settlement offers to settle debt. Ascend has data to help determine likelihood of settlement at enrollment, but creditors policies and procedures may change.Medium
Potential Taxes on Forgiven DebtForgiven debt may be taxable if the individual is solvent. Often, many individuals can qualify for technical insolvency, but that does not apply to everyone.Medium
More Expensive than Chapter 7 BankruptcyDebt settlement often costs more than a Chapter 7 bankruptcy and potentially a Chapter 13 bankruptcy.Low

How Much Does Debt Relief Affect Your Credit Score?

It depends on each situation. There is almost always a negative impact, but the extent of the impact often depends on the state of your credit score when you entered the program. Debt settlement may be the right option for someone with an 800+ FICO score as well as a 570 FICO score as depends on each individual situation. It may also not be, which is why we created a calculator to help everyone determine the plan payment cost estimates and the pros and cons for each solution.
Previously I wrote an extensive article covering debt settlement credit score impact. Credit score impact is a major concern of most folks entering a debt settlement program, so let’s get into the nuts and bolts of how your credit score may be impacted.

Debt Settlement: Credit Score and Credit Report Impact:

Many individuals researching debt settlement ask us, “How much will debt settlement negatively impact my credit score?” This is a challenging question because the impact of the credit score affect is dependent on many different factors:
  1. Credit score presently: Debt settlement will have less of a negative impact if your accounts are already behind. It will have a higher impact if all of your accounts are in good standing.
  2. Settled Account amounts: Large balances appears to have a larger impact on your credit score than low balance accounts.
  3. Creditor reporting practices: There are creditors who do not report, and other creditors only report to one of the credit bureaus. How your creditor reports will contribute to how your score is impacted.
  4. Account status on your credit report: When you settle an account, there is generally a notation that states, “Paid Settled”. This status is generally better than a charge off, but does not look as good as a paid in full.

Credit Score Debt Settlement Impact Simulation:

To understand the potential credit score impact, we ran three hypothetical simulations using the FICO simulator provided by the FICO consumer division of FICO. We simulated three scenarios where the starting credit was good credit, fair credit and poor credit. We used the definitions from Experian to define what is good, fair and poor credit. Everyone’s score is quite different (meaning that a 640 may be comprised differently than another 640).

How do we help mitigate the negative Credit Score effect?

There are three main ways that Ascend helps address this issue for people who join the Ascend debt settlement program.

  • Estimating credit report impact: We can provide free estimates during the program of where your credit score will be once you finish the debt settlement program.
  • Reviewing your credit report: Your personal finance advisor can analyze your credit report at any point in the program. Our advisors are trained to understand the credit report, so we can help find potential inaccuracies or other issues on the report.
  • Resources to help repair credit: Your advisor can show you how to dispute incorrect lines on your credit report. They will also work with you specifically on rebuilding your credit score near program graduation. If we are unable to help, we can point you to a reputable credit repair provider.

Do You Owe Taxes on Forgiven Debt With Debt Relief?

One of the biggest questions you can answer for yourself is whether you have tax consequences of debt settlement.

It depends. If you use debt forgiveness to settle a debt, you should also be aware that you may be required to pay income tax for the settled debt. The forgiven debt is treated similarly as your income, and you will have to pay a tax percentage based on your federal income tax bracket on the amount forgiven. For instance, if you have a debt of $10,000 and your creditor settles the debt for $5,000, you may be responsible to pay taxes on the $5,000 that was forgiven as it is treated as income, and the IRS expects you to pay tax on the same. You don’t always have to pay taxes on forgiven debt, so let’s get into the details.

Estimate Your Tax Consequences with our Debt Settlement Calculator

Ascend built a debt settlement calculator to help you estimate your costs pros and cons of debt settlement, in addition to a tax consequence estimator. Here’s an anonymous example of our debt settlement insights. Also, check the estimates below.

Why does IRS assess taxes on forgiven debt?

When a creditor forgives debt, they declare it uncollectible reporting the same as lost income to the IRS to minimize their tax burden. The IRS will still want to collect tax on the amount that was forgiven, and it may require you to pay tax as seen on IRS Topic No. 431 Canceled Debt. Since you don’t have to pay the full amount owed, the IRS will consider that as taxable income. The rule is applicable even for money owed after foreclosures, and in this case, besides losing your property, you will also pay tax on the difference of what you owed and that amount your property was sold that is if the deficiency is forgiven.

How creditors report forgiven debt to IRS

After forgiving your debt, the lender sends you Form 1099-C indicating cancellation of debt and the amount forgiven and date when the debt was forgiven among other things. The IRS has an entire About Form 1099-C section that may be helpful to read. If the Form 1099-C has incorrect information, you should contact your lender for corrections. The creditor sends the same form to the IRS at the end of the year. The form reports the amount of debt forgiven as income, which requires you to report the amount as income when you file your tax returns.

You may not receive the form, but the lender will have to submit one to the IRS. Failure to indicate the forgiven debt as income while the lender has given the same information to the IRS attracts a tax bill or even a notice which will cost more in penalties and interest.

How taxes on debt settlement works

Forgiven debt once reported to the IRS is taken as income, and thus it is subject to taxation. Lenders are required to send you the Form 1099-C Form by January 31st.  Once Form 1099-C is filed with the IRS, you will have to file the forgiven debt as income which will be taxed when filing your returns at the end of the year. If for instance, you owed $10,000 and your creditor forgives $5,000 then the remaining $5,000 forgone by the creditor will be treated as income and it is taxable.

How you may qualify to be exempt

The Internal Revenue Code gives room for several exceptions where the amount of debt forgiven is not subject to income tax. If you were insolvent before the lender forgives your debt then even if they issue Form 1099-C, you will not be required to pay income tax on the amount forgiven. If your debts are more than your assets, then you are considered insolvent.

What does it mean to be insolvent?

For instance, if you have assets worth $100,000 and debt of $120,000, then you are considered insolvent by $20,000. Therefore if a $30,000 debt is forgiven, which is more than the amount that you are bankrupt you will only be required to pay income tax for $20,000 while the $10,000 is exempted. If the amount of debt forgiven is less than the amount that you are insolvent, then that amount will not be subject to taxable income and you don’t have to report the same as income.  

What does it mean to be solvent?

For instance, if you have assets worth $100,000 and debt of $10,000 then you are considered solvent and you would owe based on the amount of money that was forgiven.

If you are bankrupt and your debt is forgiven, you are not required to pay income tax unlike for insolvency and home loans. Bankruptcy only cancels the debts that were in existence by the time of filing. Student loans have different sets of taxation rules, and in case it gets forgiven, the amount is treated as taxable income. The law applies to government loans and not private loans.  

If a friend or family loan you money and they decide to forgive the debt, then IRS will take it as a gift and you will not have to report as income.  Equally, if the amount forgiven qualifies under the farm or business exclusion, then the amount will be exempted from tax.

How to Account for Taxes on Debt Settlement

Debt settlement may be right for you, but then you have to be mindful of taxes of the debt settled. If not exempted to pay taxes on the amount then you should be prepared to make your tax returns on the income. It is therefore essential to know whether your forgiven debt is taxable so that you can plan to prepare the tax bill.

If you have a debt that has been forgiven and you are not insolvent, then you will have to declare that as gross income in your tax returns. If you are exempted and still receive form 1099-C you will have to use Form 982 and state the amount that should be exempted from the gross income. After establishing how much of the forgiven debt is taxable add the same to Form 1040 as other income in Schedule 1 line 21.

It is good to start preparing your tax bill once your debt has been forgiven, and immediately you get Form 1099-C to start the process. If what is reported by IRS is different from your gross income. Always notify the amount forgiven as taxable income even if it is below $600 and you don’t receive Form 1099-C.

Tax Advice

We encourage you to seek the services of a tax professional to get an understanding of the amount of tax you owe. If you are not in a position to pay your tax bill always try and file on time. Penalties and IRS charges for failure to file is 5% of the amount you owe, and for every month you are late on your returns you will attract 25% of the unpaid taxes.

If you paid your taxes and realized that the debt forgiven was exempt from tax you can still amend your tax returns by filing Form 1040X. Ensure Form 982 accompanies your amendment to show the exemption and then submit the amended tax return through email.

How Does Debt Relief Work In Specific States?

Each state often has differences when it comes to debt relief. For example, a Chapter 7 bankruptcy attorney fee could be more expensive in Florida than Michigan. Or, you may have a higher homestead exemption in California than New Jersey. As such, check the state articles below for your specific state to understand state specific details.

Debt Relief Alternatives

There are many alternatives to debt relief. The most common are debt consolidation, debt management and bankruptcy. Liz Frazier offered some great alternatives when your credit profile is intact and you haven’t experienced a hardship. Her article covers such options balance transfers, HELOCs, and person loans. We have articles for debt management vs debt settlement, debt settlement vs. bankruptcy and debt consolidation. I would like to highlight the different alternatives below.

Debt Management vs Debt Settlement:

Debt Management companies (or Credit Counseling) work as an intermediary between the individuals owing the debt and the creditor. These companies work with your creditors to reduce interest, and the Credit Counseling firms don’t typically negotiate to reduce debt amount. The enrollee generally deposits money into an account managed by the debt management company, which is then used to fund the creditors over a specific period of time, generally between 3-5 years. This period is inflexible as the creditor generally sets a maximum time limit to resolve the debt. The debt management company will do the following for the enrolled participant.

Debt Settlement vs. Bankruptcy:

There are two main types of bankruptcy: Chapter 7 and Chapter 13. The main difference between Chapter 7 and Chapter 13 bankruptcies is that all your debt is wiped out in Chapter 7 regardless of what you owe. Student loans are generally not discharged in either type of bankruptcy.    

Chapter 7: Unlike a Chapter 13 bankruptcy, you have to qualify for a Chapter 7 bankruptcy based on income guidelines by household set for each state. The most recent Median Income guidelines set by the Census Bureau started May 1, 2019 and can be found here. We created a Chapter 7 calculator for you to determine whether you qualify.

Chapter 13: Chapter 13 takes more time and is more involved. A Chapter 7 bankruptcy can be completed in around 90 days, and a Chapter 13 bankruptcy can take three to five years. There are also limits as to how much debt and which debts you can include. We built a Chapter 13 calculator for you to estimate your plan payment and compare your options.

When you file a Chapter 13 bankruptcy, it can be similar to a structured settlement plan in a debt settlement in that you have to pay some or all of your debts. The amount that you pay typically depends on the type of debts included in the bankruptcy and how much you owe to your creditors. There is also a waterfall of payment priority with the first payments made to your lawyer(s) and the lowest priority to your unsecured creditors.  

Debt Relief Common Questions:

There are common questions that we receive regarding debt settlement, so I wanted to provide a list of the most common questions:

Are debt relief companies legitimate?

You may read have the CFPB reports on debt relief and the evolution of debt relief and wonder whether debt relief companies are legitimate. We cover this top in great detail in our article titled, “Are Debt Relief Companies Legitimate?” The short answer is that it depends on which company. You should look for the red flags and green flags about each company before you make your decision. For example, you may search online for Google Reviews or “Debt Settlement Company Name reddit” (i.e. National Debt Relief reddit) to read reviews. For example, some people have had negative experiences working with a debt relief company.

We work with only 3 debt settlement companies that have gone through extensive research before we decided that these companies were offers the best services to their customers.

How much do Debt Settlement companies charge for their fees?

Debt Settlement Fees: Many companies will charge fees based on the amount of debt that you enrolled in the program. Fees vary from company to company. It’s important to have a clear picture of the fees before enrolling in a program. Choose a debt settlement company that does not charge fees until AFTER the first debt has been resolved.

Bank Account Fees: There is often a bank account fee for setup and a monthly ongoing fee. The monthly fee can be between $7-$15 per month, depending on what services are provided.

Other Fees: Be cautious on any other fee that is being charged. You may want to consider a different debt settlement company if fees are being charged before services are being offered.

Will debt collectors still contact me if I enroll in a debt settlement program?


The short answer is “no” if the debt settlement company is doing its job right. The debt settlement company should send a power of attorney form to your creditors. Sending a power of attorney will direct all future calls to the debt settlement program and provide relief.

How is Debt Settlement different than Debt Consolidation?

Debt consolidation often refers to a debt consolidation loan which is new debt to repay existing debt. Debt settlement is where a company or you negotiates your creditor for a lower rate because your debt is unaffordable. It is not a loan.

We built a comparison tool to help show the differences between the two options. We also wrote an entire article on the pros and cons of debt consolidation.

Can I negotiate on my own?

Absolutely. We’ll even walk you through this process during a call. This can be the most inexpensive option. There are cons such as managing creditors, managing payments, preventing lawsuits, speaking with creditors, etc. Negotiating on your own is the most inexpensive option.
If you negotiate on your own, you may want to consider gathering as much cash as possible to offer a lump sum payment. We have seen that creditors see lump sum offers more favorably than a payment plan when possible.

Will I be sued by a creditor?

Creditors may send the debts to collections agencies and/or law firms to collect your debt. It’s important to ask the question how they prioritize your debt when researching debt settlement companies. For example, the debt settlement company should have a robust strategy to help prevent lawsuits.

Do additional fees and/or interest accrue on my debt when it goes delinquent?


Creditors generally continue to add interest and late fees onto your delinquent balances until the point of charge off. This means your balance may increase until your account is in settlement. Debt Settlement companies will know how to minimize your total costs when determining your negotiation and payment strategy.

Is Debt Relief Best For You?

This depends on your situation. Debt settlement can be a good option for some, but Debt Management or Bankruptcy may be a good option for others. What you may want to do is take our free debt settlement cost and options calculator below that helps compare debt relief to debt management, Chapter 7 bankruptcy and Chapter 13 bankruptcy. It's 100% free, and doesn't even require an email address.