What are the disadvantage of debt settlement vs bankruptcy? We have all heard about settling taxes and debts on radio and TV instead of filing a Chapter 7 or 13 bankruptcy. But many Debtors find out a year or more later after paying debt settlement companies they wasted time and money. So how does a Chapter 7 or Chapter 13 bankruptcy compare to debt settlement?
Debt Settlement vs Bankruptcy
High Failure Rates
To begin, the debt settlement companies ask you to pay them instead of credit cards. After paying the debt settlement company a significant amount of money they attempt to settle these debts. However, they have little or no power to force credit card companies to accept offers. As a result, most debt settlement companies rarely force below settling for 50% or less. Conversely, Bankruptcy court judges often issue federal court orders to repay 10% or less. Plus, most people complete a Chapter 7 bankruptcy over 99% of the time. However, people rarely successfully complete debt settlements which are repaid over several years.
What You are Not Told
What debt settlement companies do not tell you is that you can negotiate directly with credit card companies. In fact, debt settlement companies often file bankruptcy themselves taking your money with them. As an example, see how Ameridebt took the money and then filed bankruptcy. The fact is, most people are never able to complete these debt settlement plans and file bankruptcy anyway. In fact, an overwhelming number of people who sign up with debt settlement companies eventually file a Chapter 7 or 13 bankruptcy.
If you are unable to complete a Chapter 13 you might be able to convert to Chapter 7 or obtain an early discharge. On the other hand, if you don’t complete debt settlement you lose the money paid but you still owe the debts. In fact, you might even end up owing more than your original debt after the debt settlement company takes charges and the debt interest continues to accrue.
Damage to Your Credit Rating is Less with Bankruptcy
The damage to a credit rating is about the same or less with Bankruptcy as a debt settlement. Either way, debts are not repaid. However, at the end of the bankruptcy, a debt is normally reported as account closed. That language makes it sound more like it was paid. However, a debt settlement reports as charged-off or unpaid.
Some Debt Settlement Companies are Frauds
In one fraudulent scheme, a debt settlement company instructed a debtor to transfer all of his legal property to them to avoid the claims of creditors. They did this by claiming that these legal documents would keep creditors from successfully suing him. Then, they sold his assets.
Debt Settlement vs Bankruptcy and Taxable Income
In debt settlement, any debt that is settled is treated by the IRS as income for tax purposes and the lender issues a 1099-c as if you earned income. That means that if a credit card company forgives $30,000 worth of your debt, you pay income taxes on 30,000 as if you earned $30,000. Conversely, Bankruptcy does not treat discharging the debt as income. Even if a 1099 is issued, the tax code exempts debts discharged in a bankruptcy from income taxation.
Debt settlement offers very little benefit but a Chapter 7 or 13 bankruptcy eliminates debt with no tax consequences. Refer to our Bankruptcy Manual on how to file Bankruptcy. You may also call me, Nick C. Thompson, Louisville, Kentucky Bankruptcy Attorney at 502-625-0905.
Nick used to work for the banks before he went to law school.He was married to the president of the Mortgage Bankers Association and worked in the state tax department as a prosecutor.He was also the assistant county attorney in Bullitt County.