Can Credit Card Debt Affect Your Tax Return?
The following is presented for informational purposes only. Consult with a tax professional for questions specific to your unique situation.
Credit card debt can have an affect on your credit rating, but what about your tax return? Will you be able to get your refund if you have an account in collections? What about settling a debt? Will there be any tax consequences?
These are all good questions. Here’s what you need to know:
If you owe money to a credit card company, they cannot garnish your refund to cover your debt. However, they can put a lien on your bank account and seize your funds after they’re deposited.
Your tax refund is safe from garnishment from credit card companies and collection agencies. But they are able to take you to court for your debt and receive a judgment in their favor, meaning the court may order you to pay what you owe. If this happens, the credit card companies and collection agencies can levy your bank accounts or garnish your wages.
Read more: Is Wage Garnishment Bad for My Credit?
Only the government can garnish your tax refund, and only for debts you owe to the government like unpaid state or federal taxes, unpaid federal student loans, or child support. As long as you don’t owe money to a state or federal agency, your refund will be processed and sent to you.
But if you request your refund to be directly deposited to your bank account, a collection agency with a lien on your account could take those funds even if they are a tax refund. If you have a judgment against you, you may wish to request a refund check by mail that you can then cash.
Settling with your creditors can have a big impact on how much money you get back come tax time.
If you settled any of your credit card debt for less than what you owed over the past year – and the difference was greater than $600 – you will receive a 1099-C form from that credit card company. The difference between what you owed and what you actually paid is considered “income” by the IRS. This means you will need to pay taxes on it. Depending on how much you settled, it can even change your tax bracket.
Don’t ignore it. The company you settled with will send this form to the IRS as well, so it will eventually catch up with you. But by then, you may also be responsible for late fees and penalties for not reporting it.
Read more: How to Create a Repayment Plan with the IRS
If you did settle debt over the past year, start planning for how much you might owe in taxes for the amount that was forgiven. As a general rule of thumb, plan on 30 percent towards federal and 10 percent towards state. These numbers may be different based on your income and filing status.
Credit card debt will not prevent you from receiving your tax refund, but it can affect how much of a refund you receive if you had a debt settlement. If you think you may owe taxes due to a debt settlement, start planning now so that you can save for what you will owe.
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