It’s January, which means federal income tax season is once again right around the corner. The tax code is long and complicated and covers almost every imaginable scenario, even debt relief. That’s right — if you received debt relief services such as credit card debt settlement or a mortgage modification in 2010, then you’ll likely be considered to have cancellation of debt income and will probably owe federal income taxes on the portion of forgiven debt.

While that reality isn’t any fun, it’s a lot better than being audited. And although we’re not tax experts, we’ve provided a helpful summary of what you might be looking at in terms of tax responsibilities resulting for debt relief services. Of course, we recommend that you consult a tax professional who can help you prepare your return accurately. After all, you don’t want to make mistakes with the IRS.

Generally speaking, you’ll probably owe federal income taxes on cancelled debts if the cancelled amount exceeds $600. Possible sources of cancellation of debt income include credit card debt settlements, loan discounts or modifications, and home loan modifications.

Nonbusiness Credit Card Debt Relief

You might be able to exclude cancelled nonbusiness credit card debt from federal income if the cancellation occurred in a title 11 bankruptcy case or you were insolvent immediately before the cancellation. Otherwise, you’ll probably have to pay taxes on the forgiven debt.

Loan Discounts and Loan Modifications

For loan discounts and loan modifications, you’ll likely owe income taxes on the amount of the discount or the amount of the principal reduction if are personally liable for the debt (called recourse) and keep any associated collateral. However, if you’re not liable for the debt (called nonrecourse) and you didn’t keep the associated collateral, you don’t have cancellation of debt income and you won’t have to pay taxes.

Home Mortgage Modifications

Whether you pay taxes and how much you pay on home mortgage modifications is complicated. You might be able to exclude some or all of a principal balance reduction from federal income taxes, especially if the reduction was secured through the U.S. Home Affordable Modification Program (HAMP). For more information, see the sections of IRS Publication 4681 on Qualified Principal Residence Indebtedness, including the subsections under Exclusions and Reduction of Tax Attributes.

Exceptions

Exceptions from cancellation of debt income may include income from cancelled debts as the result of a gift, certain student loan forgiveness programs, certain types of deductible debt, and often when reductions in collateral prices occurred after a sale.

Exclusions

Exclusions from cancellation of debt income are provided in some cases of bankruptcy and in insolvency and in some cases of qualified farm indebtedness.

Remember, this is just a brief rundown of some of the things you’ll need to know about your tax liability resulting from cancelled debts and debt relief services in 2010. You should use this information simply to help get your paperwork in order before consulting a tax professional.

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Fraudulent mortgage debt relief schemes that falsely promise to help troubled homeowners get mortgage modifications through the federal government ranked as one of the top scams of 2011 by the Better Business Bureau (BBB).

The consumer information organization released it’s top 10 scams of 2011 on Wednesday, detailing the top scams from nine categories including identity theft, sales, check cashing, home improvement, and job offers. Mortgage modification scams ranked as the top financial scam of the year. In a tenth category, the BBB’s infamous Scam of the Year award went to a phishing scam in which millions of consumers got fake emails that looked like official notifications from the BBB (“BBB Names Top Ten Scams of 2011,” BBB press release, Jan. 4, 2011).

In schemes related to deceptive mortgage modification services, websites were often set up on the Internet that purportedly had a connection with the federal government’s U.S. Home Affordable Modification Program (HAMP), which was set up by the Troubled Asset Relief Program (TARP) to help homeowners facing foreclosure alter the terms of their mortgages, including things like lowering monthly payments or principal balances, so they can stay in their homes. However, the scammers had no connection or insider access to HAMP and were simply charging exorbitant fees for a service that HAMP provided for free.

“In challenging economic times, many people are looking for help getting out of debt or hanging on to their home, and almost as many scammers appear to take advantage of desperate situations,” the BBB said in a statement. “Because the federal government announced or expanded several mortgage relief programs this year, all kinds of sound-alike websites have popped up to try to fool consumers into parting with their money. Some sound like a government agency, or even part of BBB or other nonprofit consumer organization. Most ask for an upfront fee to help you deal with your mortgage company or the government (services you could easily do yourself for free), and almost all leave you in more debt than when you started.”

A total of $29.9 billion in TARP funds has been set aside for foreclosure prevention programs such as HAMP. Through the first 11 months of 2011, 756,407 homeowners nationwide received default notices on their home mortgages and 742,649 homes were repossessed. Various state and federal officials around the country brought actions against mortgage debt relief scammers in 2011. SIGTARP, the federal agency responsible for monitoring fraud in TARP, for example, shut down 125 alleged mortgage debt relief schemes in November that had advertised on the popular search engines Yahoo, Bing, and Google. The investigations as led to criminal charges against 17 people, including three sentenced to prison (“Foreclosure Crisis Spurs Epidemic of Mortgage Modification Scams,” Detroit Free Press, Jan. 4, 2011).

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Paying off debt was the third most popular financial New Year’s resolution for 2012, according to Fidelity Investments. But shedding your debt can be harder than dropping those extra pounds. For people with significant debt, professional debt relief agencies that provide debt management, debt consolidation, or debt settlement services can be helpful tools for getting out of debt. Whether you seek professional help or are a do-it-yourselfer, here’s four New Year’s debt relief resolutions that anyone can use to make a real difference in 2012.

1. Stop using credit cards

The first thing you need to do to get out of debt is to stop using credit cards. As Bill Hardekopf, chief executive of LowCards.com says, “Don’t be throwing dirt on yourself when you’re in the hole already.” Put those credit cards away and start paying off as much credit card debt as you possibly can. Stick to cash or debit cards for your expenses and you’ll be doing yourself a tremendous favor, one that can help get you you out of debt and keep you there for the rest of your life.

2. Build an emergency fund

Between car notes, home loans, and credit card balances, you’re probably looking at interest rates anywhere from 2 percent to 29.99 percent — in fact, the average credit card interest rate is 14.56 percent, according to Bankrate.com. It might sound silly at first to sock cash away in a savings account that pays less than 1 percent interest, but building up an emergency fund will help prevent something like a blown tire or a doctor’s visit from causing you to break out your credit card to cover the unexpected expense. Having an emergency fund is just as important as paying down your debt. Ideally, you should aim for enough savings to cover three to six months of living expenses.

3. Consider taking advantage of balance transfer offers

Balance transfer offers from credit card companies can help you pay off your debts, but you’ve got to play it smart. Some offers may sound great, like 0 percent interest for up to 21 months, but you have to avoid the pitfalls contained in the fine print, such as interest rate hikes up to 19.99 percent or higher after one late or missed payment, and need to be able to pay off the balance in the promotional timeframe. After the promotional period expires, so do those low interest rates. And whatever you do, don’t buy anything with your transfer card. You’d just be throwing gas on the fire and going deeper into debt.

4. Look into a debt consolidation loan

If you decide not to seek help from a professional debt relief agency, you might be able to get a debt consolidation loan to help pay off your debts. If you have high interest rates from things like credit cards, an unsecured personal loan with interest rates of 10 percent or less might be a good deal. But a word of warning: a debt consolidation loan is like dynamite. According to Scott Halliwell, a financial planner for USAA, a debt consolidation loan in the right hands can do a lot of good, but “it’s pretty dangerous” if used incorrectly. You could end up deeper in debt if you fail to budget payments and you can end up owing more down the road if your repayment term is too long.

The key to keeping your debt relief resolutions this year starts with not using your credit cards. It’s that simple. Cut them up if you have to, but stop using them to buy stuff. Once you budget your monthly expenses and switch to a cash-and-carry lifestyle, you can start making some decisions about building an emergency fund, transferring your credit card balances, or looking into a debt consolidation loan. If you find you’re still struggling with your debt, you can always contact a debt relief professional.

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