Bankruptcy v. Debt Settlement

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Bankruptcy expert Leon Bayer answers real-life questions.

Dear Leon, 

I’ve got trouble. I just got sued by a credit card company for around $9,000. I have one other delinquent credit card debt for about $15,000. I make around $32,000 per year. It takes all my money just to live. Those are my debt issues, but here’s the real trouble. I have leukemia again, after being in remission for almost five years. I live in California. 

I will be starting chemotherapy soon. I am physically reaching the point where I have to go on disability. My life savings is about $7,000 in an IRA account. That’s all I’ve got, plus really excellent health coverage from my job. I would like to settle with my two creditors, provided they remove anything derogatory from my credit report. I can get a letter from my doctor to show the creditors if that will help me get settlements. I understand that if I make settlements, I might owe some extra income taxes? 

So, what in the world do I do? Any insights from you would be a huge help to me right now. 


Keith C.

Dear Keith,

Thank you for reading our bankruptcy blog. I understand what a pernicious disease you have. I hope you will knock it down and get back into remission. You have asked if I can explain your legal options. I know you don’t expect a perfect answer to such tough questions, but I’ll do my best to help.

Debt settlement is certainly an option for you. Bankruptcy is another option. Let’s analyze them both.


Based on what you mention, bankruptcy is probably an option. You have just a couple of old debts that should be dischargeable, you have no assets to lose, (your IRA account will be protected) and you already live pay check to pay check. You sound like a perfect candidate for Chapter 7 bankruptcy.

My only hesitancy over bankruptcy is that you might be stuck with large future medical debts if you lose your insurance. Also, the best of medical plans could leave a person owing a lot of money under some circumstances. Hopefully that won’t happen to you. However, a lawyer should be able to point out all possible outcomes that are reasonably foreseeable.

Debt Settlement

Now, let’s analyze debt settlement. My law partner Jeffrey Wishman is an absolute wizard at settling debts. He feels that given your financial and medical circumstances, settlements as low as 25% of the total owed may be possible, especially if your doctor provides a diagnosis letter with a grim prognosis. Sharing a letter like that with your creditors can be extremely helpful during the negotiation process. If successful, debt settlement will free you from your present debt worries.

However, even a 25% debt settlement is going to use up all the money that you have. I really don’t want you losing all your savings to pay for debt settlements, especially since you have no present ability to replace your savings. Also, you will soon be on disability which may provide less income than your normal salary.

Taxes Owed on Forgiven Amounts in Debt Settlement

Let’s examine the possibility of you owing income taxes on the amount of debt that gets forgiven. Forgiven debt is counted as income, and normally you would owe incomes taxes on that money, just the same if it had been earned in that amount at your job. Fortunately, there is an exception to that rule, and the exception is in your favor.

An individual will not owe any income tax on the forgiven portion of debt, provided that you were financially insolvent. Insolvency is measured by the value of all your assets and comparing that to the total of your debts. If you owe more money than the value of all your assets, you are insolvent. Based on what you said in your question, you are insolvent unless you own something of value that you haven’t mentioned. I am assuming that all of your personal property such as clothing, furniture, appliances and personal effects have no real value. You do have $7,000 in your IRA, but that is less than the total of all your debts. Hence, you are probably insolvent.

(To learn more, see Nolo’s article Tax Consequences When a Creditor Writes Off or Settles a Debt.)

Can You Get Derogatory Information Removed From Your Credit Report?

Now let’s examine your request that any settlement include a deletion of negative information from your credit reports. That will not happen. Here’s why that is.

Credit reporting is a big business. Credit bureaus sell your credit report to financial institutions. Those banks and other institutions rely on the accuracy of the reports in making decisions to extend credit to you. You can’t manipulate your report by deleting true but derogatory information. To learn more, see our articles on Credit Repair.

The Best Option for Now:  Do Nothing

Now, for the BIG question:  What should you do? My advice – do nothing right now. Absolutely nothing. Here is my thinking. If you file for bankruptcy now, you might have more debt from medical bills later. And if you settle your debts, you won’t have any money left.

Both your disability income and your IRA can’t be touched by creditors. In the meantime, the creditors can all have fun going to court, but you don’t have anything they can take from you. When you are out of the woods and back to work, it will probably be the right time for you to file bankruptcy.

I hope you are well soon. Consult bankruptcy lawyers whenever questions arise.


Leon Bayer is a Los Angeles bankruptcy attorney.  He is a partner at Bayer, Wishman & Leotta, a California law firm specializing in bankruptcy.  The opinions and advice in this blog post are from Mr. Bayer alone, and should not be attributed to Nolo.  By answering a question on this blog, Mr. Bayer does not become your lawyer.

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