How to Write a Letter of Compromise to Settle Debt

A letter of compromise is a formal proposal to a creditor to settle a debt for less than the full amount owed. Its purpose is to communicate that a significant financial hardship prevents you from paying the debt in full. By presenting an honest picture of your financial situation and making a realistic settlement offer, you initiate a negotiation to resolve an account whose original terms have become unmanageable.

Information and Documents to Prepare

Start by locating the exact legal name of the creditor and the correct mailing address for their settlement or collections department. You will also need the full account number associated with the debt to ensure your correspondence is routed properly.

Next, construct a personal financial statement, which is a snapshot of your current financial reality. This statement must list all sources of monthly income and itemize all recurring household expenses, such as rent, utilities, and transportation costs. The statement should also include a list of your assets, noting the fair market value of items like cash or vehicles, alongside a full accounting of all other debts.

This financial statement must be supported by verifiable documentation. Collect copies of recent pay stubs that show a reduction in income, official statements for unemployment or disability benefits, or a termination letter from a previous employer. Significant medical bills or bank statements showing low balances also serve as evidence. You will send copies of these documents to the creditor with your letter.

With this information, determine a realistic settlement offer. The amount should be a sum you can pay as a single lump-sum payment, which creditors prefer because it represents guaranteed funds and a quick resolution. While the offer is often a percentage of the total debt, it must be a credible amount based on your documented hardship.

How to Write the Letter of Compromise

Your letter should be professional and direct. At the top of the page, list your full name, current address, and the specific account number. This ensures the creditor can immediately identify your account.

In the first sentence, declare that you are writing to offer a settlement for the specified account due to financial hardship. A clear statement of intent is more effective than a lengthy introduction.

The body of the letter should begin with a concise and factual explanation of your financial hardship. Refer directly to the personal financial statement you prepared, summarizing the key factors that prevent you from paying the debt in full. For instance, state that a job loss has reduced your monthly income or that new medical expenses have consumed your disposable income. Avoid emotional language and focus on presenting the facts of your situation honestly.

Following the explanation of your hardship, present your formal offer. State the exact dollar amount you are proposing as a settlement, for example: “I am offering a one-time, lump-sum payment of $X to be considered as settlement in full for this account.” If a lump-sum payment is impossible, you could propose a short-term payment plan, but this is often less attractive to creditors.

In the closing section, reiterate that your payment is offered as a full and final settlement of the entire debt. You should also provide a reasonable deadline for their response, such as 30 business days, to encourage a timely reply.

Submitting Your Offer and Next Steps

Send the complete package via United States Postal Service (USPS) Certified Mail with a return receipt requested. This service provides you with a mailing receipt as proof of sending and a signed receipt from the creditor upon delivery. This creates a legal record of when the creditor received your offer.

After submitting your offer, the creditor will review it. Wait for a formal, written acceptance letter before sending any payment. Review the letter carefully to ensure it confirms the settlement terms. It should state that upon receipt of your payment, the debt will be considered settled in full.

A creditor may also reject your offer outright or respond with a counter-offer. A counter-offer initiates a negotiation, where the creditor proposes a different settlement amount that is higher than your initial offer but likely still less than the full balance. You will then need to evaluate if you can meet their new terms or if you need to respond with a revised offer. The creditor may also request additional information to verify your hardship claim.

Upon reaching a successful agreement, ensure the final terms are documented in writing by the creditor. Make your payment using a traceable method, such as a cashier’s check or money order, and never send cash. Retain copies of your original letter, all correspondence, the final written agreement, and your proof of payment indefinitely.

Tax Implications of Settled Debt

Settling a debt for less than you owe can have tax consequences. If a creditor forgives or cancels $600 or more of a debt, the Internal Revenue Service (IRS) considers the forgiven amount to be taxable income. The creditor is required to report this to you and the IRS.

You may receive a Form 1099-C, Cancellation of Debt, from the creditor, which reports the amount of debt that was forgiven. The IRS also receives a copy of this form, so it is important not to ignore it. Failing to report this canceled debt as income on your tax return can lead to an IRS notice and potential penalties.

An exception to this rule exists if you were insolvent immediately before the debt was canceled. The IRS defines insolvency as a situation where your total liabilities are greater than the fair market value of your total assets. If you meet this definition, you may exclude the canceled debt from your gross income, but only up to the amount by which you were insolvent. For example, if $5,000 of debt was canceled while your liabilities exceeded your assets by $3,000, you could exclude $3,000 of the canceled debt from your income.

To claim the insolvency exclusion, you must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, with your federal income tax return for the year the debt was canceled. Given the complexities of these rules, consulting with a qualified tax professional is advisable to ensure you are correctly calculating insolvency and filing the necessary forms.