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I am sure you have all seen those debt relief commercials on television, promising to reduce your debt without bankruptcy. There are a few things to remember about these agencies. First, even though they say they are non-profit, the IRS has revoked the tax exempt status of many of these agencies (see link below). This is because in order to be a true tax-exempt non-profit agency you have to put the public first and have a benevolent interest. The IRS has found that many of these agencies are working with credit card companies and are taking large fees from consumers and not looking out for the consumer.

The way these agencies is work is by having you pay them money each month, where a percentage of the money you pay each month goes to pay the agency's fees (sometimes up to 50% of what you pay them) and the other percentage is put aside. The agency tells you to stop paying your creditors (and your interest and late fees continue to accrue) and then the agency attempts to make lump sum offers in compromise - using the money they have been putting aside for you each month as a lump sum (which means they have to wait until there is enough money to make a lump sum payment).

What the agency does not tell you is that you could do the exact same thing on your own - and have 100% of the money you put aside go towards your creditors to make offers in compromise. These agencies have no greater ability than you do to negotiate with creditors, even though they suggest they do in their commercials. Second, these agencies are not always clear about the fact that if you make an offer in compromise, you are are very likely going to have to pay income tax on the debt that is forgiven. This is called "debt discharge income" and the IRS will tax you on it. The creditor must send you (and the IRS) a 1099 if the debt forgiven is over $600. So if you have a debt of $5000 and you settle for $2500, you may have to pay income tax on the $2500 that was forgiven. This is not necessarily a reason not to make an offer in compromise. The tax on $2500 is less than $2500. It is important to know ahead of time however what the tax ramifications are, so you can prepare for them. (There are no such tax consequences when you file bankruptcy).

Third, when you stop paying your credit cards, the interest and late fees continue to accrue. You need to keep this in mind because most creditors won't even consider a lump sum settlement until you are significantly behind and your debt can increase by hundreds of dollars by that time. Fourth, your credit will show a debt "settled for less than full balance" and that will stay on your credit report for seven years. When clients come to me for bankruptcy, I always examine their case to see if there are non-bankruptcy alternatives. For people with small amounts of debt, offers in compromise may very well be the way to go. I have educated clients on how to make these offers and explained to them the pros and cons of doing so. A good bankruptcy attorney is going to look out for the best interests of his or her client - even if that means making less money. Lawyers have an ethical obligation to do what is best for the client, not what is best for the lawyer's bottom line. (IRS website explaining their investigation of these debt relief firms: http://www.irs.gov/charities/article/0,,id=156842,00.html)