Meaning of Debt Forgiveness

It is many a debtor's dream to just wake up one day and be told that their debts have been forgiven, and they don't have to worry about them anymore. And while this ideal - where every debt someone has gets forgiven - is hardly ever played out in the real world, it turns out that many creditors today are actually increasingly offering an arrangement called 'debt forgiveness' through which debtors can have at least a part of their debts forgiven.

The arrangement is really quite simple. What happens is that the creditor informs the debtor that they will 'forgive' them a portion of their debt, as long as the debtor makes an effort to pay the rest of the debt in lump-sum. If, for instance, a debtor owes $10,000, the creditor could inform him that they will forgive them $2,000 (a considerable sum of money by all accounts), as long as they can pay them the remaining $8,000 in a one-off (lump-sum) payment. The creditor here rationalizes that it is better to get $8,000 than to have to write off the whole $10,000 (which is a very real possibility with increasingly delinquent debtors). And in any case, the $2,000 portion of the debt they forgive is probably what they would have had to spend in chasing the debt around. So for the creditor, debt forgiveness turns out to be very worthwhile. But is debt forgiveness worthwhile to the person whose 'debts are forgiven?'

To get insights as to whether debt forgiveness is worthwhile to the person whose debts are forgiven, we have to examine the long term effects of debt forgiveness.

In the long term, debt forgiveness could have a number of negative effects. Starting with taxation, you have to keep it mind as you go about getting into a debt forgiveness agreement that the amount of money that you will be so 'forgiven' will be treated by the tax authorities as an income, and taxed as such. Indeed, when the amount is added to your income from other sources, it could push you to a higher income tax bracket, and cause you to be taxed more by a bigger margin than the forgiven debt itself.

For one, when the taxman comes calling, you will be surprised to learn that they treat the amount of debt that was forgiven as an income - and actually tax it as such. It gets worse, should the forgiven debt amount actually push you to a higher tax bracket, in which case you might end up paying more in taxes than you would have received as debt forgiven, just on account of your having received it. And for the creditor to have considered you for debt forgiveness, chances are that you would have been highly delinquent in your repayments. But while they may forgive you in monetary times, chances are that they - if only out of good corporate citizenship - are likely to report the matter to the credit bureaus, leaving a blot on your credit report.

So when all is said and done, debt forgiveness could turn out not to be a worthwhile thing to the person it is supposed to benefit: the debtor.

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