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Too Good to Be True-Banks Urging Relief for Credit Card Holders?
With middle income families facing financial disaster during these surmounting adverse economic times, an unprecedented alliance has formed between big credit card financial institutions, including Citibank, Discover, bank of America, JP Morgan Chase, American Express amongst others (who have already taken financial hits by boosting up their bad debt loss reserves to the tune of between $1 billion to $3.5 billion) with consumer advocates and approached the U.S. government with a proposal that would permit qualifying credit card holders to be forgiven up to 40% of their credit card debt with possibly reduced interest rates and avoid bankruptcy. If adopted, the actual amount of debt reduction would depend on the circumstances in each case. Initially, this would involve a pilot program involving 50,000 debt ridden middle class people. Basically, the way it would work would be, assume that a qualified debtor owed a combined $40,000 in credit card debt of which 40% was forgiven (or $16,000), the remaining $24,000 would be paid off over time, possibly at reduced interest rates. Of course this would be reported to credit reporting agencies and remain for 6 years, but it may (depending on the individuals circumstances) be a better alternative to bankruptcy which a) stays on your credit report for 10 years, and b) under the new bankruptcy law, a person with a job may find their Chapter 7 (total discharge) case converted to a Chapter 13 "wage earner's plan" which means paying the entire debt off over time. Much remains to be worked out however I will watch this and update for developing news.
Income Tax Consequences- Few people realize it but Internal Revenue Code Section 61 defines income which includes "forgiveness of indebtedness income". What this means is that under existing tax law, if you default or are otherwise permitted by a lender, or business who sold you goods on credit, not to pay the remaining balance owed, including interest, that amount is required to be reported to the IRS on Form 1099-C and included in your taxable income. Exceptions to this rule are limited and include insolvency, bankruptcy or negotiated settlement of a disputed indebtedness. So assuming that you are in a combined federal and state effective tax bracket of 20%, $16,000 in forgiven installment debt (or any debt) would mean an extra $3,200 added to your tax bill for the year in which the debt was forgiven.
Under the proposed change, reporting of the amount of the forgiven indebtedness would be deferred until the end of the loan payout.
Too good to be true? Now if all this sounds too good to be true, it may just be. More needs to be learned concerning who would qualify and how the proposed plan would be administered. Also, would federal taxpayer funds be involved? As many of in the northeast know all too well, the cost of living (including housing, gasoline, food, etc.) is much greater in some states than others, and wages are higher as well. If such a plan were adopted, it would require an administrative fairness for it to be truly effective to everyone living across the country as well as those whose debt has already been written off by the lender and purchased by debt collectors who may have already filed judgments and liens.