@AmandaCRich wrote:
OK, thank you. I just don't understand how/why I'm paying taxes on money o never actually had, but that's fine... So, aside from insolvency there's no way to avoid these taxes from the debt forgiveness?
You did get the money.
If you borrow money, you get the money tax-free, because it is not considered income if you promise to pay it back. If you don't pay it back, it becomes taxable income (money that you get to keep for free). In this case, you say credit card, so apparently you bought some items or got cash advances, never paid the money back, so it becomes taxable income.
The situation you are discussing is not clear, and there are two possible taxable events happening. Suppose you have $10,000 of credit card debt, and the bank agrees to settle if you pay a $6000 lump sum right now. You borrow $6000 from your retirement fund to settle the debt. Taxable event #1 is that the $4000 of forgiven debt is taxable, and the bank will probably issue a 1099-C for the canceled debt. But, the amount of the 1099-C should be the amount forgiven, not the entire amount. (And, in fact, if the bank issues a 1099-C, they are not allowed to collect any money after that date.)
Borrowing money from the retirement plan is not taxable if you repay it. But if you stop repayments (because you leave the job, for example), then any remaining balance is taxable to you when you stop making payments, that's taxable event #2. It's taxable because you withdrew money from the retirement plan, and withdrawals are always taxable, no matter what you do with the money after you withdraw it.
