Dear Let's Talk Credit,

I just received a notice from a collection agency that states the original balance due on the debt was $20,743.97. There is also a settlement amount listed of $2,074.39. It is saying they are providing an opportunity to "settle this account" by paying $2,074.39.

I am concerned this is just a way to get the $2,074.39 and then they will continue to request the rest. I am willing to pay the $2,074.39. The problem is that it is not my debt. I am afraid that if I pay that amount the person I am paying for will now start to get more phone calls, etc. I don't want to create a bigger problem than what she already has.

If I pay, they might say, "you paid this so now pay this." However, they do not know it is not her paying. Is this a legitimate request from the company and if I pay, will the debt truly be settled? She is like an ostrich with her head in the sand and won't take care of business. I can do this for her, but ... 

- Diane

Dear Diane,

The first rule when settling a debt for less than the full balance owed is to get the settlement agreement in writing. The agreement should state that by paying the settled amount, the debt is paid in full. Should you decide to pay the offered amount to settle the debt for your friend, do not send in the payment until you have the agreement in writing.

Because the settled amount is only 10% of the total debt, it is likely that this debt is quite old and past the statute of limitations to sue for payment in court. In addition, the debt is probably too old to be reported on your friend's credit report. These are both positive things regarding the debt, but other than the debt still being owed, there could be another negative surrounding the debt.

Should you decide you can afford to pay off the debt for your friend, the collector is required to issue a 1099-C tax form for the forgiven amount of the debt. The IRS considers debts that are forgiven to be taxable income. Because the forgiven amount is large in this case ($18,669.58), your friend could end up with a hefty tax bill.

The IRS states that if a debt is not actively in collections, a cancellation of debt (1099-C) should be issued after 36 months of nonpayment. That time period has most assuredly elapsed, so your friend may receive a 1099-C tax form, even if she doesn't settle the debt. She just needs to be aware of the possible tax consequences of not paying the debt or not paying it in full.

If your friend receives a 1099-C, she should consult a tax professional to see if she qualifies for any of the canceled debt exclusions. If she qualifies, that would mean she would not owe taxes on the forgiven amount.

Let's keep talking!

See related: 6 cancellation of debt exclusions