For many consumers the lure of a 0% introductory rate can be enticing to purchase big-ticket items, but after 18 months McKinley says those rates shot up to 24.99%, leaving him with more than $4,000 in debt across three cards. It didn’t help that in December 2003, he also lost his job working at a local casino.

With no income or emergency fund at the time  McKinley relied on his credit cards to survive. He did this for three months  before finding employment with a national bank in Philadelphia. But by then, the 36-year-old divorced father of two was knee high in debt—$21,000 worth to be exact. “I thought to myself, ‘This has got to stop, this is crazy.’” His situation instantly reminded him of his late mother, Denise McKinley, who had accumulated and maxed out more than 20 credit cards. She eventually filed for bankruptcy.

But unlike his mother, he decided against bankruptcy. “I made the debt, and I need to pay it,” he says. First he transferred the balances from his three store credit cards to his Chase and Discover credit cards, which offered lower interest rates. He used the bonuses he received from his new job with the Department of Homeland Security as a supervisor for the Transportation Security Administration and his salary increase to aggressively attack the debt. He has also found ways to curb spending. For example, as a TSA employee he receives free monthly public transportation cards from the federal government. By taking the train to work he saves, on average, $120 per month, an amount he also applies to his debt.

But even with all his efforts he soon realized that his strategy for digging himself out of debt wasn’t making a dent. “What I was paying was only going toward the interest. Every time I would get a new statement it would be higher than what the previous statement balance was,” explains McKinley.

McKinley reached out to his lenders for help, asking for lower interest rates or a payment plan option to reduce his monthly bill. His requests were denied. Frustrated, he researched ways to reduce his debt and came across a debt solutions company that negotiates with lenders on a debtor’s behalf for a $45 monthly fee. He enrolled in the program in August of 2007. Within a few months McKinley says he noticed a change. His Chase credit card interest rate was reduced from 31.99% to 6%; Discover 14.99% to 12.99% (later increased to 15.64% after canceling the debt management program); Bank of America 19.99% to 9%; Zales 24.99% to 9.9%; and his Midas card stayed the same since the balance was low.

Today, McKinley has paid off $17,500 of his debt. Now, he has just about $3,500 outstanding and is proud of how far he has come. But he also feels that he has put so much emphasis on attacking his debt that he has neglected other areas of his financial life. As a result, his retirement contributions are way behind schedule, he has minimal funds in his emergency savings account and has not developed  a plan to pass on generational wealth to his children.

McKinley has less than $300 in his checking and savings accounts, $350 in an emergency fund, and a little more than $3,000 in his retirement account. “I’m living paycheck to paycheck. I’m turning 37 next year and I need to start thinking about retirement and securing my future,” he says.

The Advice
Black Enterprise and AXA retirement planning specialist Ilyas Akbar reviewed McKinley’s financial situation and offered the following advice.

Start investing for retirement. McKinley has forfeited approximately $18,000 in employer match dollars by not contributing 5% to his retirement account since he started in 2004. “Minimally, he should increase his contributions to at least 5% of his salary to take advantage of his employer match,” says Akbar. Based on his current take-home pay, McKinley should contribute approximately $310 per month into the plan, which is about 7% of his pay. With his employer match of 5%, this will help put him on track for retirement.

Finish paying off debt. For McKinley to really secure his financial future, he must commit to a savings and investing plan and not incur any new debt. Akbar recommends that he use the $2,000 Financial Fitness Contest winnings to pay down his highest interest debt (Discover Credit Card; $3,395 at 15.64% APR). After applying the $2,000 toward that debt and with continued payments of $150 a month to the remaining balance ($1,395), he can pay off his balance in about nine months. McKinley also has a medical bill for about $1,394, toward which he pays $120 monthly. He should continue making those payments and will have that bill paid off in 12 months. Akbar then suggests that he redirect the $270 toward his retirement and savings. McKinley should continue his $305 monthly payments toward his automobile loan.

Build an emergency fund and curb spending. Akbar suggests that McKinley focus on building at minimum three months, but preferably six months, of emergency reserve funds for regular monthly living expenses. Taking public transportation saves McKinley $120 a month, which he should apply toward his emergency savings. McKinley estimates that he can reduce his monthly cable bill from $145 to $85 by switching to basic cable. Once his contract with his cell phone carrier ends in January, he plans to change service providers. His bill is currently $90 a month and a new plan under MetroPCS will be $50 a month. be suggests he apply these monies toward his emergency fund. Once he reaches his six month goal he can then funnel that money into his high-yield savings account.

Get life insurance and an estate plan. McKinley has life insurance through his employer, in which $8.40 is deducted from his paycheck per pay period. Akbar suggests that McKinley obtain term life insurance to protect his two children. Term insurance will allow McKinley to obtain a higher level of death benefit with less impact on his budget. This is especially important since his 6-year-old son has special needs. He should work with an insurance professional to determine the amount and length of the term contract. McKinley should also have a will prepared by an attorney and explore a supplemental needs trust for his son with special needs. Life insurance can be used as a funding vehicle for this trust. He should also look into long-term disability since there is no employer-provided long-term disability benefit. This will protect his earnings and savings in the event of a prolonged disability.

Plan for his children’s education. McKinley has two sons, ages 6 and 16 (for which he pays $668 a month in child support). Once he has adequately addressed savings, retirement, life insurance, and develops an estate plan, he can consider utilizing a 529 plan to save for his youngest son’s education. The 529 consists of after-tax contributions, but offers tax-free growth and tax-free withdrawals for qualified educational purposes. Since his oldest is just two years shy of enrolling in college, be recommends that he apply for grants and scholarships. He should also consider staying in state, since local colleges generally have lower tuition and fees for residents.

Monitor credit annually. After closing four of his five credit cards, McKinley’s FICO score took a huge hit. be suggests he get a copy of his credit report from the three national credit reporting agencies every 12 months at www.annualcreditreport.com. Make sure that the information in the report is accurate and up to date. Any errors should be addressed with the Federal Trade Commission. He should beware of credit repair scams and use resources such as the Federal Trade commission’s site to learn how to improve his creditworthiness and to find legitimate resources for low or no-cost help (ftc.gov/credit).

Documenting—on paper—how much money comes into your home, how much flows out, and how much you save is the first step toward tracking down those disappearing dollars.

Creating a budget can also help to uncover the source of financial problems. But according to the National Foundation for Credit Counseling, only 40% of American households use a budget. The rest take a hit-or-miss approach, never really knowing whether they’re living within their means, in need of a better-paying job, or in a position to rein in their debts.

The good news is budgeting isn’t difficult. One thing it does require is a deep look into your current financial picture and more than a bit of discipline. To show you how it’s done, black enterprise found three subjects in need of financial organization and paired them with advisers to help them draft workable budgets.

Photo by Rayon Richards

Chanel Graham worked two jobs to put herself through college, but six years after graduating she is still struggling to make ends meet. “I’m stabilizing after years of being in debt,” says Graham, co-founder of I Kissed Dating Hello, a website. With a monthly income of about $3,250 (she earns $250 each month from freelance writing jobs), Graham says she’s “frustrated by the constant feeling of not being able to pay the bills.”

With about $600 in savings, Graham pays $1,300 for housing and $100 for transportation every month. Credit card bills, food expenses, and miscellaneous spending cost her $1,450. As a devout Christian, she gives $350 per month in tithes to her church. Graham doesn’t have a budget, but she recently came up with a “plan” to save $500 a month.

Graham says, “I’m also trying a new system of putting $100 a week on a second bank check card that I can use for lunch and miscellaneous spending.” Graham, who is engaged, is saving for her wedding, which will be held next summer. She projects that it will cost about $5,000. “I would also like to go back to school, but I’m hoping to pay down my credit card debt first,” she adds.

Jessica Broadnax-Lawrence, a family financial counselor with Consumer Credit Counseling Service in Chattanooga, Tennessee, says Graham first needs to figure out what portion of her income should be applied to paying down debt. “Then she should budget enough to cover flexible expenses,” says Broadnax-Lawrence, who also urges Graham to save while paying debt.

“It’s better to pay double the required minimum payment amount on credit card balances, because interest accrues over time,” says Broadnax-Lawrence. “This will help her pay down her principal balances. While saving is always a good idea, weigh the interest rates of the debt and savings, and decide where your money should go.”

Depositing $100 on a bank card each week isn’t the best way to help Graham balance her spending, says Broadnax-Lawrence. Instead, she should set aside cash in the amount that she plans to spend. This way, Graham can avoid incurring bank fees or overdraft charges.

After subtracting expenses from her income, Graham ends up with $300 a month—not enough to meet her wedding savings goals (which would require $416 per month). “To be able to save enough money for periodic emergency expenses, she needs to revise her wedding budget,” says Broadnax-Lawrence.

Graham’s budget should limit household expenses to roughly 35% of her total income, and debt payments to about 20%. Other expenses (including transportation) shouldn’t exceed about 20% of total income, and savings should be 10%, according to Broadnax-Lawrence.

Because freelance income fluctuates, Broadnax-Lawrence says Graham should treat that money like petty cash and focus solely on her base salary when budgeting. “To get to solid budgeting numbers, she should use her salary only, and focus on saving the rest,” she advises, “or use it to continue paying down her debt.”

Photo by Chris Hamilton

Najla Slowe understands the value of budgeting, and she knows firsthand what can happen when people let their finances unravel. As an administrative assistant and marketing consultant for a bankruptcy attorney, she works about 35 hours a week and brings home $1,800 a month. She’s tried to map out a budget for herself in Microsoft Excel, but admits that she “rarely looks at” the spreadsheet.

With two small children, Slowe is having a hard time making ends meet. “I’m in debt,” says Slowe, whose student loans are now in deferment. “My biggest financial challenge is finding a way to live within my means, while searching for a job that will increase my salary.” Slowe says she hasn’t put much time into the latter.

With no savings, Slowe spends $760 per month on housing and $260 on transportation, including gas and auto insurance. She spends about $650 on other living expenses. Her children are enrolled in after-school care that costs $264 per month. On the bright side, Slowe has no credit card debt. Even so, she’s living pretty close to the edge.

There’s little wiggle room in Slowe’s current situation, namely because moving into a less expensive apartment isn’t an option. “If I get a cheaper apartment, I may end up in a bad neighborhood,” she laments. “As a single mom, that would be pretty dangerous.”

Doug Robinson, owner and financial adviser at DouglasBradley L.L.C. in Bel Air, Maryland, says Slowe’s biggest budgeting issue is not spending, but income. With $21,600 a year coming in, and two young children to raise on her own, Slowe earning even another $5,000 a year in income could have a marked effect on her  budget, Robinson says. He advises Slowe to focus her energy on searching for a job with a target annual salary of $28,000 or more. She should also pursue some form of child support.

“If she wants a better-paying job, she has to get out there and start looking,” says Robinson. “She should also set clear financial goals and create timelines to stick to.”
Slowe might also consider sharing living space and housing costs with another single mom (perhaps someone she meets through church or a community group) in order to reduce her expenses. “Her No. 1 expense is housing, but she shouldn’t move into a bad neighborhood just to save a few bucks a month,” says Robinson.

The arrangement could last for just a year or two—enough time for Slowe to gain some financial footing. “It doesn’t have to be forever, but if sharing space and increasing her income helps her achieve her goal of financial independence by 40, then she needs to get started with these strategies today.”

Najla Slowe
Age: 33
Location: Atlanta
Family status: Single, with two children
Primary budgetary goals: “I want to organize my bills, plan for the future, and achieve excellent financial standing by my 40th birthday.”

Ideal Budget for Najla:
Based on her current income, here’s what Najla Slowe should ideally be spending, maximum, on each expense:
After-tax monthly income: $1,800
Housing costs: $630 (if she were to find a roommate to share expenses with)
Transportation costs: $260
Other expenses: $360
Childcare: $260
Monthly savings: $180
Monthly surplus would be: $110

Key suggestions: Find a roommate with whom she can share housing expenses; look for ways to increase annual income.

Photo by Greg Platcha

Kasheen and Regina DeMoss financial goals mimic those of most Americans. They want to pay their monthly obligations and still have enough left over to cover vacations, new cars, college educations, and retirement. Unfortunately, the pair isn’t making ends meet on their monthly income of $7,200. Kasheen works in transport operations and Regina is a customer support manager.

“I think we’re doing OK, but according to financial guru Suze Orman, we’re doing horribly for our ages,” says Regina, who admits that even when she budgets for simple needs like groceries, she regularly spends over her target amount. The pair enjoys two vacations each year, and shops for clothing and other accessories once a month.

The DeMosses have no savings, but Regina has $8,000 in her Roth IRA. They spend about $1,500 per month on housing, $700 on transportation (one car payment plus insurance and gas for both autos), and $1,000 on monthly credit card bills. Other recurring monthly expenses come to about $1,000, including food; and the family spends about $240 a month on grooming (hair and nails).

“Our youngest son will be 16 next year and will need a vehicle, and my car has more than 100,000 miles on it,” says Regina. “He’ll be attending college in three years, and we don’t have any money saved for that.” The couple’s 20-year-old son is working.

Sheila Chesney, president of Chesney & Co., in Sheldon, South Carolina, says the DeMosses should kick off their budgeting strategy by focusing on one financial goal at a time, and then figure out how to achieve it.  “It’s almost impossible to save for retirement and college and new cars at the same time,” Chesney says. “That’s how people get into trouble.” Right now, for example, she says the couple should be focused on saving for retirement by starting a retirement plan for Kasheen, and contributing regularly to Regina’s existing plan.

Kasheen & Regina DeMoss
Age: 43 (Kasheen) and 41 (Regina)
Location: Raleigh, NC
Family status: Married with four sons, two of whom live at home (ages 15 and 20)
Primary budgetary goals: “We want to save for new cars [for Regina and the couple’s youngest son], plan for our son’s college, be ready for retirement, and do a better job of investing in a 401(k).”

Ideal Budget for Kasheen and Regina:
Based on their current income, here’s what Kasheen and Regina DeMoss should ideally be spending, maximum, on each expense:
After-tax monthly income: $7,200
Housing costs: $1,500
Debt/credit card payments: $1,440
Other expenses: $1,440
Savings: $1,020
Potential Monthly surplus: $1,800
Key suggestions: Carefully assess all expenses; tell son to earn cash for his car and college expenses; cut back on vacation spending; put bulk of monthly surplus into retirement savings.

“They need to figure out the maximum they can contribute to each, and get it done,” says Chesney. She suggests setting up a plan that will allow them to replicate the income they now earn, a combined $86,000 annually, when they reach age 65.

The next step is to inject some frugality into the family budget, which is being stretched to the limit by vacations, luxuries like designer clothing, and a son who isn’t contributing financially. “You give your kids the best advantage when you teach them how to earn their own money at a young age,” says Chesney.

Unless there is an immediate need to replace Regina’s car, Chesney says the DeMosses should forgo the new car goal and instead funnel the money into their retirement accounts and college savings (the latter of which could also get a boost if their son were to get a part-time job). “There’s nothing that says parents have to pay for college,” Chesney points out. “They should encourage their son to start researching grants, loans, and scholarships, or attending a more affordable community college first. If he does well and saves some of his own money, he could transfer after two years.”

Chanel Graham

Age: 27
Location: Brooklyn, NY
Family status: Engaged
Primary budgetary goals: “I would love to have a solid plan in place, and to relieve myself of the constant anxiety I feel regarding my finances.”

Ideal Budget for Chanel:
Based on her current income, here’s what Chanel Graham should ideally be spending, maximum, on each expense:
After-tax monthly income: $3,250
Housing costs: $1,225
Debt/credit card payments: $700
Food, transportation, and other expenses: $700
Monthly savings: $325
Monthly surplus: $300
Key suggestions: Continue to pay down debt; approach wedding savings realistically; budget for emergency expenses.

That’s right. Credit card issuers, banks, and debt collectors who agree to accept at least $600 less than the owed balance are required by law to file 1099-C forms with the IRS. In addition, they send a notice to debtors. In turn, the debtor must report that “income” on his or her federal income tax return.

Here’s an example: Let’s say you owed $10,000 on a credit card and sometime in 2010 you negotiated with a collector to pay off $6,000 to cancel the debt. The credit card issuer will report the forgiven $4,000 you didn’t pay off as taxable income. In the eyes of the IRS, you earned an extra $4,000 in 2010. What can really cause financial pain is when people who’ve experienced a foreclosure receive a 1099-c in the mail. Banks often issue the notices when they sell a foreclosed home for less than the previous owner owed on their mortgage. In some cases, the foreclosed person gets slapped with a 1099-c that adds hundreds of thousands to their earnings for the year.

The 1099-c has been around since 1994, but its use has been growing in recent years. The annual number of 1099-c forms filed with the federal government by creditors and debt collectors nearly doubled between 2003 and 2008, according to the IRS. The IRS received a just under 1 million forms in 2003 and more than 1.99 million in 2008. This year, the number is expected to grow to 2.8 million, and for the 2011 tax year: 3.1 million. Experts believe the spike is partly due to the rise in mortgage foreclosures and settled credit card debt.

“Depending on the amount of debt forgiven, the taxpayer’s income level, deductions and other factors, the consumer could face a sizable tax bill come April 15th,” explains Ben Woolsey, Director of Marketing and Consumer Research for CreditCards.com. “Few consumers are aware of the tax implications of settling to pay a lesser amount than they owe in credit card debt, and never expected their debt settlement would be considered income.”

Since many consumers don’t know what the 1099-c forms are, some may throw out the notices because the forms come from creditors or debt collectors with whom they assumed they had settled. Other taxpayers are not filing the 1099-c with their federal income tax returns, putting them at high risk for IRS audits, penalties and fines.

Woolsey and other experts at CreditCards.com offer five tips for preventing and handling forgiven debt when it resurfaces at tax time.

•Get professional advice: Consumers who receive the 1099-C cancellation of debt forms should immediately take them to a tax preparer or tax adviser.

•Prevention is key: Consult with a tax adviser before finalizing debt settlement agreements to find out the potential tax implications. Ask for a tax preparer who has experience with the 1099-c.  Also clarify with the creditor or debt collector the exact amount that will be declared on the 1099-c form.

•Check your mailbox: Be aware that the 1099-c is coming and don’t throw it away. Take it directly to your tax preparer.

•You may be excluded: Taxpayers may qualify for one of several exclusions that allow them to reduce taxable income from canceled debts.  Look into the details, and if the exclusions apply to you, file an IRS form 982 in addition to the 1099-c.

•Beware of inconsistencies: If there is a dispute about the amount reported on the form, contact the creditor or debt collector immediately to resolve the matter. Then ask for a corrected 1099-c form.

Be sure to also read these related articles…

• New Study Shows 62% Drop in Home Mortgage Approvals to Minorities
• The Statute of Limitations on Debt
• Smart Money Moves for Every Stage of Life

I really want to get out of student loan debt. I’ve been paying on my loan for the last eight years and I have $12,000 left to pay. I was thinking of taking all my money out of savings and just sending my lender one big check. Would the benefit of getting out of debt outweigh the cost of cleaning out my savings account? I’m a disciplined saver and I have a steady job, so I know I can build it back up again.

—S. Johnson
Brooklyn, NY

I see that you’re itching to kick this debt to the curb—but not so fast. You would be doing yourself a grave disservice by depleting your emergency savings fund. The economy has not fully recovered and the job market is still shaky. What would you do if you lost your job tomorrow? Your financial discipline won’t matter if there’s no money coming in. The majority of your unemployment benefits will evaporate once you’ve paid for food and housing.

You have to move past the discomfort you’re feeling today and actively prepare for financial security tomorrow. My suggestion is that you continue to pay your loan as usual. And if you haven’t already, start taking advantage of the tax breaks that paying student loan interest provides. The interest is tax deductible regardless of whether you fill out the short or long form. In any event, resist the urge to raid your emergency savings.

O'Brien asks if debt is as serious a problem as racism

This Thursday at 9pm, CNN airs a new installment of its popular documentary Black in America. In this episode, host Soledad O’Brien takes a look at “almighty debt,” its effect on the black community and the role of the black church in helping us live debt free. In addition to interviewing Pastor DeForest Soaries of First Baptist Church in New Jersey–who makes living debt-free an integral part of his message to his congregation–O’Brien attended Black Enterprise’s Golf & Tennis Challenge to talk with our editors about the ways debt management (or lack thereof) affects our lives.

How you think about money can leave you drowning in debt

It’s no secret that Americans are mired in record amounts of debt. The average credit card debt per household is $15,788, according to CreditCards.com, an online resource center for consumers. “The root cause of the skyrocketing debt is interest rates, or accrued interest,” says Dr. Donald Reid, a Brooklyn-based certified financial planner. “Many people have no clarity on the actual real cost of money.” Where are Americans going wrong when it comes to dealing with debt and managing finances? Check out these five financial blunders that will lead you to ruin.

Not looking beyond teaser rates: Mortgages with low interest rates attracted many now embattled homeowners. Low interest and down payment offers make big item purchases – cars, homes, electronics – even more attractive. “It’s called a teaser [rate] or Adjustable Rate Interest,” says Reid. “I give you 1% for the first five years and at the end of that five years, it’s going to shoot up to 15%.” Before making a purchase, it’s important to get an idea of what the monthly payments will be once the teaser rate expires. Online calculators can give consumers an idea of future payments.

Failing to understand the business cycle: While economic growth is experienced over long periods of time, economies also experience periods of correction and expansion during the short term. In other words, for every boom, there is an economic bust that’s sure to follow.  “Banks were of the opinion that property values would go up ad infinitum,” says Reid, regarding the once booming housing market. “What we have right now is a correction.”

“It” can happen to you: Reid says that while many people saw others losing their homes and teetering on the brink of a personal financial depression, most people were still disconnected from their own reality: “A lot of people said, ‘It can never happen to me. That’s happening to those people out in Manhattan or on the other side of the country,’ and then they were hit with foreclosure.” Even with careful financial planning and management, unforeseen events are sure to arise. Whether it’s socking away $20 a week in a money market account, establishing contingency plans for financial stability in case of a job loss, or emergency medical expenses, plan for the unexpected. Remember, “it” can happen to you.

Staying mum on money: “Talking about financial security conveys a sense of financial insecurity,” says Reid. So instead of discussing finances, it’s politically correct to leave those issues behind doors, he adds. But that’s one reason many are currently in financial ruin. An open dialog with your spouse, partner, children, family and friends can help you gain insight into how you should manage your own money, and allow you to paint a realistic financial picture.

Personal conditions are not permanent: Whether you’re the CEO of a thriving enterprise or at an entry level position, one thing is constant–change. And it happens in a flash, says Reid. “If your job or your business goes south, guess what? The family is going south with you,” he says. But just as quickly as you can be thrust into a financial abyss, you can also gain the resources and tools needed to rise from the ashes. It’s important to understand that your job is not secure, and it’s wise to have other sources of income as well as your emergency savings. Steer clear of spending more than you make and practice living below your means – and bank the difference.

Don't be misled by the false promises of a debt settlement company. Do your research.

Debt settlement might seem like an easy out, but there are many risks involved. Learn what to watch out for by reading part one of this post, What You Should Know Before Settling Your Credit Card Debt. If you’re considering hiring the services of a debt settlement company, get as much information as possible about the process. Before you sign on the dotted line, here’s a list of the top 10 questions you should ask.

1. What are your fees?
Most of the fees should be based upon performance and results. Many companies charge a flat fee based upon a percentage of your debt amount. Their fees are collected in the beginning months of the program, even if no settlements are completed. If fees are based upon a percentage of the debt and not tied to results, this is a big red flag.

2. How long have you been in the debt settlement business and how much debt have you settled?
Many companies don’t settle much debt at all, and young companies have very little experience. If the company cannot demonstrate experience, this is another red flag.

3. Can you stop my creditors from calling me?
It is not possible to stop all creditor calls. If they say they can, beware.

4. Will you be making monthly payments to my creditors?
Settlement companies do not make monthly payments to your creditors. They should not claim to do so or give you the impression that they do.

5. Can I get sued?
Yes, there is a possibility that you could get sued. Don’t believe it if the settlement company acts like it can’t happen to you.

6. Will this have a negative effect on my credit report?
The correct answer to this question is “Yes.” Settled debt will have a negative impact on your credit report.

7. When can I expect my first settlement?
Your first settlement should be made well within the first 12 months of your program. If it takes any longer than 12 months, this is an indication that your settlement is not being handled correctly.

8. Can you tell me exactly how long this will take and exactly how much this will cost?
Debt settlement is not an exact science and there are too many variables to come up with exact time frames and figures. Many companies will tell you anything to get you in the door. They should not make any attempt to provide exact information.

9. Are there tax consequences I should be made aware of?
Yes. The IRS considers forgiven debt to be taxable income, though you may be able to get the taxes waived if you can show the IRS you are insolvent. This should be explained.

10. Who is holding my money while I’m waiting on a settlement?
Your funds should be held at a third party escrow company in an FDIC-insured trust account. The company should not tell you to send the funds you are saving for the settlement to them.

Source: Credit.com

Sheiresa Ngo is the consumer affairs editor at Black Enterprise.

I had a portion of my debt canceled after working out a debt settlement. A friend of mine said there’s a catch to this arrangement because I’ll have to pay taxes. Is this true? Will I have to pay taxes on the forgiven portion of my debt?

—R. Grant
Queens, NY

It depends on the type of debt that was forgiven. According to the IRS, forgiven debt is taxable because it’s counted as income. And the forgiven amount must be reported as income. You should expect to receive a form from your lender known as Form 1099-C, cancellation of debt. Credit and debt collectors who forgive a minimum of $600 from a debt such as credit card, auto, or mortgage are required to file with the IRS. You’re entitled to a copy of the paperwork.

You didn’t mention what type of debt you had canceled, but there are some cases where you might be eligible for an exclusion from paying the taxes (Note: you may have different tax obligations on the federal and state level). One example is mortgage debt. Under the Mortgage Forgiveness Debt Relief Act, if your mortgage is partially forgiven from 2007 through the 2012 tax years, you might be eligible to apply for tax relief and exclude the forgiven debt from your income. Debts discharged during bankruptcy are also eligible for exclusion.

Your best bet is to check with your tax professional who can advise you of your federal and state tax obligations. (Read “Choosing the Right Tax Professional” Shopsmart, April 2008). You can search the National Association of Tax Professionals online database by zip code to find a tax preparer in your area.

Pay down and avoid credit card debt. Cut costs and eliminate unnecessary spending. When you do spend, shop around for the best bargains.  Boost personal savings; establishing an emergency fund equal to at least six months of living expenses. Create a household budget and stick to it.

The funny thing is, these are the smart money habits we should have been practicing all along, the wealth-building lifestyle that Black Enterprise has always stressed in both good and tough economic times. In fact, the people suffering most during these times of economic stress are the ones who ignored these common sense rules of personal finance. When times were flush, they bought more home than they could afford, bigger cars than they needed and made every luxury a necessity. But if you look around, you’ll notice that some of us are less stressed than others. They are the ones that used our most recent and lamented period of economic growth not to spend more, but to boost savings, reduce debt, control spending and solidify their financial positions.

The silver lining of these tough economic times is the bracing but liberating realization that we can live on less, and we should have been doing so all along. Good money management habits are not just for recessions. We should not wait for an economic downturn to force us to do what we should have been doing anyway. Let’s hope that we retain that lesson when the economy rebounds.

Alfred Edmond Jr. is the editor-in-chief of BlackEnterprise.com