Credit Counseling Versus Bankruptcy

Not all credit counseling agencies and debt reduction companies are created equal as described in a recent article I read called Risks of Using Non-profit Credit Counseling Agencies. Managing to qualify as a non-profit organization does not necessarily mean that the organization is free from corruption or greed. In a recent article, I wrote about a trend that I have recently observed where real estate agents tend to oversell the benefits of a short sale. I am seeing similar overselling of the benefits of credit counseling.

Every bank is required to notify the IRS when it forgives over $600 of your credit card debt. This forgiveness of debt may result in you owing thousands of dollars in back taxes, interest and penalties. If you need debt reduction, you can obtain the same result tax free in a Chapter 13 wage earner's reorganization. The big advantage that a Chapter 13 bankruptcy has over credit counseling and debt reduction companies is that the repayment plan is a binding court order and can deal with all of your creditors. Private debt repayment plans only bind the creditors that are willing to negotiate with you.

Some attorneys will go so far as to say that should not even consider hiring a debt reduction company until you get a guarantee in writing that the debt reduction will not result in back taxes owed to the IRS together with penalties and interest. Keep in mind that not all forgiveness of debt is taxable income. However, it is taxable to the extent the taxpayer is solvent or is rendered solvent by the forgiveness.

Like short sales, credit counseling and debt reduction companies are not a magic pill to save your credit rating and make your debt problems disappear. Credit counseling is an important service to help you regain control of your spending habits. However, the best what determine what is the most beneficial solution for your situation is to seek the advice of a competent attorney and a tax professional.

About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar and the San Diego County Bar Association. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.