When you’re trying to get your business out of debt, you have some options. However, regardless of what you choose to do, you’ll need to consider the tax consequences of debt relief.
Covering All the Angles
If you can negotiate with creditors and end up with a debt consolidation or a debt settlement, you’ll have to consider the taxable implications of finding relief that way as well. What basically happens is that, in the US, the Internal Revenue Service considers funds which have been excised from debt to be income.
According to DebtSettlement.co, how a debt settlement affects your taxes boils down to paying taxes on the subtracted sum: “If…savings [is] $400…the creditor will issue a 1099-C to you at the beginning of the following year, which shows the $400. You are required to report it as income on your personal tax return.”
If you get your debt reduced and don’t pay your taxes, you’re not out of the woods. Here’s the thing: There is no shortage of consolidation agencies which neglect to spell this out. They may have you sign a 1099-C, but they never explain it. And such a thing can be easy to forget.
Imagine that you’re a small- to medium-sized business offering tours of historical St. Augustine. Things are going well, but you had to take out a loan in order to properly market to tourists. Well, unfortunately, you did that before an economic downturn that undercut your profits and made it impossible to pay back the loan on time.
You managed to renegotiate the terms of the loan, consolidate your debt, and cut a thousand dollars from what you owe. This gave you some debt relief, but then, when you file your taxes the following year, you forget to incorporate your debt savings as additional income. Suddenly you’re under audit, and you didn’t save receipts for the year in question.
RELATED ARTICLE: EVERYTHING YOU NEED TO KNOW ABOUT DEBT FINANCING
Businesses Are Exceptionally Vulnerable
Well, the above is a real scenario. The sad truth is, you’re more likely to experience such a scenario if you’re a business. Certainly, personal debt can backhand you with such sequences of events, too, but as a business you’re more visible to the IRS. Especially if you’re successful.
All that being said, there are quite a few positive attributes to debt consolidation which make such debt relief solutions worth your time. If you can cut $1,000 from debt you owe through negotiations, and you only have to pay 25% tax on that, then you’ve managed to save $750. That must might be the rent payment you need to stay open.
When you go into negotiations for debt relief, ensure that the person you’re working with reviews all the angles with you. It may turn out that reducing what you owe isn’t your best choice. In that case, you’ll want to look at other ways of reducing your debt burden.
Consolidation and Crossover
For example, if you can consolidate multiple debts into a single payment through a consolidation loan, then it’s likely you can cut multiple debts with varying interest rate increases into a single loan at a fixed interest rate. When you’ve got debt at interest from four locations, the interest can fluctuate on all those debts.
Meanwhile, a single payment will only have one interest stream. Additionally, there are ways to reduce the size of that fixed-rate interest. For instance, you could obtain a consolidated loan with a cosigner, giving you considerable debt relief.
This is especially feasible for businesses that have a lot of crossover. As an example, if you’re a tourist agency in St. Augustine, you might work with a group that conducts water tours by renting sailboats to tourists. If that business currently has a good bottom line they might agree to cosign on a consolidated loan for you. In that event, you’re likely to get a better interest rate on your loan. In return, you could send tourists their way, and everybody wins.
The key here is to consider all the angles and think outside the box. Do those things and you’ll be able to avoid seemingly hidden penalties like the tax consequences of debt relief.