Business Debt Settlement Cost: 6 Components of the Final Bill

When you settle a debt, you are not just paying off the amount agreed to. There is also a settlement company fee, account fee, possible litigation or default costs, interest and penalties that continue to accrue until the debt is settled, and taxes on forgiven debt. The amount that you agree to settle a debt for is the headline; what determines how expensive it actually is is how it gets paid off, and the total cost of the fees and expenses. To manage cash flow, how those payments fall over a period of time matters just as much as how much the final number is.

How Realistic Your Schedule Is

Look at the payment schedule. If you have agreed on the amount, and agree to make payments, the start date for the payments is the first thing to check. If the payment schedule matches your high and low season, the deal is much less risky, so spreading the first payment from the time of signing to a lower season, and making the installments fit your collections, will make the overall deal safer for both parties. A missed payment often does not get to rescission of the contract; it goes to a stipulated judgment for the balance of the amount.

If you don’t have the cash to pay the first installment, ask to be allowed to delay it until your next billing cycle. If you are seasonal, ask for quarterly payments. If the early installments seem large, see if the creditor will allow you to make a small first payment, and bump up payments after a few months. If you manage your cash flow effectively, an early payoff discount should have some value to you, and is worth asking for. Also ask whether the settlement can cap a balance subject to continuing interest charges, and deal with a personal guaranty that may follow. If you are working with several creditors, coordinate so payments are not stacked in the same month.

A default clause can cost you the balance of the debt, or let you fix it over time. The more generous version lets you cure the default after getting a written notice, and get credit for payments made. If your default clause costs you a judgment for the unpaid balance, and credits you for any payments you made, and gives you more than one cure period if the failure was caused by a bank error, or missing the wire cutoff, you’ve got the right default clause.

Don’t rely on anyone’s memory. Put every change in writing, signed by both parties. An oral agreement, or an email that is not countersigned, may not be enforceable. You can get to yes with a settlement at a mediation, but if it is not reduced to a writing and signed, Florida courts have held it is not enforceable. But outside mediation, as long as the essential terms are agreed on, you may not need a signed document to have a binding contract.

Fees and Costs

The FTC rule barring debt settlement companies from taking a fee until a debt is settled, a creditor agreement signed, and a payment made does not make clear whether it applies to business debts. The two allowable fee methods are paying a proportionate share of your fee as each debt is settled, or a fixed percentage of savings, the same for every debt. A quarter of $400 saved on a $1,000 debt gets you a $100 fee.

A debt settlement program may require you to make deposits into an account run by an independent third party that may charge its own reasonable fee.

While the debt reduction program is underway, even while you’re making the payments, the debts you haven’t settled yet continue to rack up interest and late fees, which is to say, the total amount you owe can actually grow while you’re trying to get out of debt. If you leave a program, you lose the fees you paid, and still owe the unsettled debts.

If the creditor hires an attorney to enforce the debt and adds attorney fees to the balance, the settlement range moves way up. And if you’re in Florida, a one-way fee clause in a note or credit application goes both ways: if you prevail, the other side may have to pay your attorney fees. Florida gives plaintiffs and defendants the ability to change the dynamics of a suit by making a formal offer to settle. The offer has to be accepted within 30 days. If the plaintiff rejects and recovers at least 25% less than the offer, the defendant gets fees and costs. If the court feels the offer was not in good faith, the award can be denied. If a settlement leaves out how the fees and costs will be paid, it leaves a second fight for the lawyers when the first one ends.

Forgiven Debt as Income

Taxes are the last hurdle: The IRS generally treats forgiven debt as income in the year it’s canceled. A lender files a Form 1099-C on canceled debt of $600 or more. If you’re a sole proprietor, report the forgiven amount as income on line 6 of Schedule C for the year when the debt was canceled.

The insolvency exclusion lets you avoid getting taxed on some or all of the forgiven debt by saying you were insolvent at the time, your debts exceeded the fair market value of your assets right before cancellation. Excluded debt can only be equal to the smaller of the canceled amount, or your insolvency (debts minus assets). To claim it, fill out Form 982. If you had net operating losses, they are reduced first.

Taxes aside, if you settle a debt and make a final payment, but don’t negotiate for a copy of the termination of a financing statement, it can stay on file long after the debt is settled, and keep you from getting a new loan. You can make sure it comes off by negotiating a release of UCC financing statements, noting the number and date of the one that’s going away. In your settlement, specify the date the filing will be released.

A settlement fixes a payment problem, not a solvency problem. If there is no payment schedule you can afford, what you need may be a workout, or a restructuring, not a settlement, and before committing to a settlement program, it may be better to test the underlying claim, and make sure you’re not waiving your rights to offsets and credits. Federal agencies have different rules on how to collect their debts; federal agencies including the SBA must send debts over 180 days delinquent to Treasury’s Bureau of the Fiscal Service for collection.