Auto Loans Settlement offer laws if any?

[Nicole Hernandez]

Jurisdiction

Arizona

I have an auto loan for 20k that I got behind in after my husband was murdered. I was offered a reduced settlement payoff for 11k. My car is worth private sale 21k and trade in 17k (just guesstimating). In this settlement offer it states that I would be given a tax form to file on my taxes. Could I trade the car in and have the new loan company payoff the settlement offer?

 

[adjusterjack]

Condolences for the death of your husband.

Rather than speculate on what ifs, I have an important question that needs answering first.

Do you have the $11000 cash to pay the settlement?

 

[Tax Counsel]

I have an auto loan for 20k that I got behind in after my husband was murdered. I was offered a reduced settlement payoff for 11k. My car is worth private sale 21k and trade in 17k (just guesstimating). In this settlement offer it states that I would be given a tax form to file on my taxes. Could I trade the car in and have the new loan company payoff the settlement offer?

My condolences on the murder of your husband. I cannot personally attest how difficult that is emotionally as I've never been in that situation, but I do know it can be devastating. I hope you are getting whatever help you need to process your grief from this. Don't ignore your own health, mental or physical. That keeps you from living the best life you can. I do know that from personal experience.

Now, to the question you asked. If your thought is that you can avoid any tax obligations from the settlement by doing this (and as I discuss below, there might not be any tax impact), then you can forget this idea. The lender you are settling with has to report the canceled portion of the debt from the settlement to the IRS no matter what you do with the car or the settlement money.

But it is important to understand that just because you recieve a Form 1099-C from the lender for the canceled debt that does not automatically mean that the canceled debt is taxable income to you. There are several exceptions under the Internal Revenue Code (IRC) in which forgiven debt is not included in current taxable income. One of the most common situations that falls into the nontaxable income category is when you are insolvent (your debts exceed your assets) both before the settlement and after the settlement. For many Americans a settlement like this falls into this exception. There are other exceptions and there are other rules that would at least reduce the taxable income (sometimes by a lot) from the settlement. For all the details, see IRS Publication 4681 on debt cancellation, the IRS page About Publication 4681 which has additional information including any changes in the law or tax regulations since the Publication 4681 came out, and IRS Tax Topic 431, Canceled Debt: Is It Taxable or Not. I suggest starting with Tax Topic 431 for the basics before moving on the more in depth Publication 4681.