Debt Settlement vs. Bankruptcy for Credit Card Debt

Debt settlement and bankruptcy are two different ways to manage credit card debt. Debt settlement results in a reduction in the amount owed to a credit card company. Bankruptcy, on the other hand, will eliminate credit card debt in Chapter 7 or will require the repayment of a portion of the debt in a court approved Chapter 13 repayment plan. Both kinds of debt management plans have advantages and disadvantages.

How Debt Settlement Works

Debt settlement is the settlement of debt for less than the amount owed. This means that the creditor agrees to accept less than the amount owed in exchange for a lump sum payment. The creditor will forgive the remainder of the debt. Debt settlement will have a negative impact on a debtor’s credit report.

Debt settlement may result in tax consequences. The IRS views forgiven debt as taxable income. When a creditor agrees to collect less than what a debtor owes, the creditor must report the loss to the IRS if the amount forgiven is for $600 or more. The debtor must report the amount forgiven as income on their tax return. If a debtor is insolvent -- their debt exceeds the value of their assets -- the debtor does not have to report the forgiven debt as income.

How Bankruptcy Works

Bankruptcy is another debt management solution. Unlike debt settlement, filing for bankruptcy does protect a debtor from creditors. When a debtor files for Chapter 7 or Chapter 13, an automatic stay prohibits creditors from proceeding with collection activities. Like debt settlement, a bankruptcy will have a negative impact on a debtor’s credit report.

Filing for Chapter 7 bankruptcy will result in the discharge of credit card debt. However, to qualify for Chapter 7 a debtor must fall within the income guideline set by their state. Filing for Chapter 7 bankruptcy may result in the debtor having to give up certain valuable property that is not exempt from seizure. The bankruptcy trustee has the right to take the nonexempt property and sell it to pay creditors.

Unlike Chapter 7, a Chapter 13 bankruptcy will not eliminate credit card debt. Instead, Chapter 13 restructures debt. The debtor will be required to repay creditors in a three or five year repayment plan approved by the bankruptcy court. In most cases, the amount the debtor must repay will be much less than the original amount owed. To qualify for Chapter 13, a debtor’s unsecured debt must not exceed $336,900 and secured debt must not exceed $1,010,650.

Always Talk to an Attorney First

It is important for people considering either debt settlement or bankruptcy to talk to an attorney before deciding. Attorneys can handle both kinds of cases, and make sure their clients are legally protected from creditor lawsuits.