USAToday.com is reporting that Credit Card issuers are looking for a little regulatory help to make it cheaper for them to forgive some credit card debt. (Article is called, Banks seek help to forgive some credit card debt.) Essentially, some banks, who are also credit card issuers, are requesting a regulatory change; so that if they forgive some credit card debt in the form of workout agreements with card holders, the banks do not have to have to book the entire amount forgiven at one time.
The way this would work is banks would identify the customers most likely to file for bankruptcy (and pay them nothing). The banks would offer those people a deal where the bank would write off up to 40% of the total oustanding balance. The remainder would then be repaid at 0% interest over 5 years. The catch from the banks’ point of view is that the total amount of the forgiven debt would have to be taken as a loss at the time the workout was done — and, as the article points out, most banks don’t need more losses right now.
From the cardholder’s perspective there are two reasons why this isn’t the world’s greatest deal. First of all, assuming that you get the maximum 40% discount and that you are approved for the program at all means that you first, have been identified as likely to file for Bankruptcy. That tells me that this credit card account is probably not your only problem. Second, let’s say that you have a $10,000 account. Subtract 40%, and you have a $6,000 account. Pay that back over 60 months, and you have a $100 a month payment — except for all the rest of the debt you are trying to pay. Most people who file for bankruptcy have already stopped making payments on their credit cards and still can’t make ends meet. This deal might prolong the pain a little (and increase the guilt), but for most people I don’t see that it is a deal changer. The difference would be if there was some cooperation between issuers so that people in serious trouble could get this deal on all their credit card accounts. I’m not seeing that as a possibility from the terms of this article.
The second problem, and one that I harp on a lot here, is that this forgiven debt will constitute taxable income; and the banks will be sending 1099’s to the IRS on your behalf. Now, the easy answer is that the people this is targeted to should all qualify as insolvent at the time that the workout deal is made; and therefore, should be entitled to not pay taxes on this forgiveness of debt income by proving to the IRS that they were insolvent. Well, unless, they have substantial equity in either a homestead or a tax qualified retirement account (both of which are fully exempt in Oklahoma and can be kept by the debtor even if they file for bankruptcy); in which case, they might not qualify as insolvent and would have to pay the taxes due on the forgiven debt — including, of course, all that forgiven interest.
Umm, yea. Sure. How many people do you know who are in over their heads with credit card debt who 1. know that they need to present the IRS with evidence of insolvency in order to avoid paying taxes on forgiven debt; and 2. know how to go about doing that? Yea, that’s what I thought. Ultimately, these people will just trade freely dischargeable credit card debt for non-dischargeable tax debt.
Not quite the deal they thought they were getting.