The tax rules in brief
- Canceled or forgiven debt is generally treated as taxable income.
- Lenders generally must send Form 1099-C when they cancel $600 or more of debt.
- If you were insolvent (debts more than assets) just before the cancellation, you may exclude some or all of it.
- Debt discharged in bankruptcy is not taxable income.
In this article
Tax facts to know
- Canceled debt: generally counted as income
- 1099-C: usually sent for $600 or more canceled
- Insolvency exclusion: claimed on Form 982
- Bankruptcy discharge: excluded from income
From IRS Publication 4681. This is general information, not tax advice.
Is forgiven debt taxable? In most cases the IRS treats the amount you did not have to pay as income. That can turn a debt settlement saving into a surprise tax bill.
Here is how it works, the main exception most people qualify for, and what to do when a 1099-C arrives.
How canceled debt becomes taxable income
The canceled amount is added to your income for the year it was canceled. Depending on your tax bracket, that could add hundreds or thousands of dollars to your tax bill.
The insolvency exclusion
You are insolvent if, just before the debt was canceled, your total debts were more than the fair market value of everything you owned. You can exclude canceled debt up to the amount you were insolvent.
Sam's insolvency worksheet
Just before his settlement, Sam owed $40,000 in total and his assets were worth $32,000. He was insolvent by $8,000.
His $7,000 of canceled debt is less than $8,000, so he may exclude all of it by filing Form 982 with his tax return.
Illustrative example. Names and numbers are made up to show how it works.
Assets include retirement accounts, cars and home equity. Debts include every loan and card, not just the settled ones. IRS Publication 4681 has a worksheet.
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What to do when a 1099-C arrives
- Check the amount and date against your settlement letter.
- Contact the creditor if the form is wrong and ask for a corrected one.
- Work out whether you were insolvent using the IRS worksheet.
- Report the income, or file Form 982 to claim an exclusion.
- Talk to a tax professional if the amount is large.
Frequently asked questions
Do I have to pay taxes on settled credit card debt?
Often yes, unless an exclusion applies, such as insolvency or bankruptcy.
What if I did not get a 1099-C?
Canceled debt may still be taxable. Check the IRS rules for your situation.
Is debt forgiven in bankruptcy taxable?
No. Debt discharged in a bankruptcy case is excluded from income.
Can a debt settlement company handle the taxes?
No. Taxes are your responsibility. Ask a tax professional before you settle large amounts.
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