Academic journal article Journal of Accountancy

Advising Financially Stressed Clients: When Debts Surpass Their Means, Be Ready with Wise Counsel

Academic journal article Journal of Accountancy

Advising Financially Stressed Clients: When Debts Surpass Their Means, Be Ready with Wise Counsel

Article excerpt


* CPA advisers can help clients In financial straits avoid bankruptcy or avoid missteps that could further cloud already bleak finances.

* Debt settlement negotiations with credit card companies should be done with caution, Any debt management agency engaged should have a good record for reliability. If a home mortgage lender offers to release other property held as collateral, clients should consult an attorney to avoid giving up valuable rights in a subsequent Chapter 13 bankruptcy.

* Various types of debt modifications can result In taxable Income to the debtor from cancellation of debt. Some types of debt forgiveness are excluded from income, but they are not without potential costs to the taxpayer. The insolvency exclusion, for example, requires a corresponding reduction of tax attributes, and one for qualified principal residence indebtedness reduces the home's basis.

* A "deed In lieu of foreclosure" that gives title to the mortgage holder in exchange for canceling the debt may be preferable to foreclosure if the amount owed far exceeds the property's value.

* Debtors facing a collection action sometimes inadvertently facilitate the creditor's collection efforts. They can take some actions to preserve property as exempt from a bankruptcy estate. On the other hand, such actions as disposing of or transferring property could run the risk of recovery by a court and could result in corresponding debts becoming nondischargeable.



Tax and financial advisers should be prepared to discuss a range of possibilities for their clients who are facing financial difficulties and help make the best choices given their circumstances and goals. Should they consider bankruptcy? If they want to avoid bankruptcy, how can they best reduce their debt? Which actions should clients avoid? Which actions should professionals handle? This article highlights some nonbankruptcy options for debt reduction and the related tax consequences and identifies actions to avoid that could cause legal difficulties if the client ultimately files bankruptcy.


A client can take certain actions to try to settle debts without filing bankruptcy.

Debt negotiations. Any debt, whether evidenced by a formal loan agreement or not, can be negotiated. A client may be able to negotiate a settlement with a creditor (for example, a hospital) for less than the balance due. However, if the agreed-upon balance is not paid, the account may be turned over to a collection agency.

Clients who want to negotiate a settlement with a credit card company should be cautious. If clients use a debt management agency, they should first check with the Better Business Bureau, the National Consumer Law Center or the Consumer Federation of America to ensure the agency's reliability. Reputable agencies and attorneys who handle credit card negotiations charge a fee for negotiating a certain number of cards, plus a deposit of up to 50% of the unpaid balance on the cards. Once a settlement is reached, the deposit is used to pay the negotiated debt balance. If the credit cards are settled successfully but the client has others that are unpaid, the client should wait at least 90 days before filing bankruptcy on the remaining debts to avoid preference challenges (discussed later in this article).

For debts that are evidenced by a formal loan document, negotiation strategies include extension and modification agreements. Extensions involve a change in the payment schedule itself. One common practice involves extending the term of the loan by tacking past-due payments on to the end of the loan. For example, if three $500 monthly payments are not made on a 15-month loan, the three $500 payments would be moved to the end of the loan, extending the term of the loan to 18 months. Interest would typically continue to accrue daily, increasing the total amount paid over the life of the loan. …

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