A creditor that forgives $600 or more of a debt generally has to report it to the IRS and send you a Form 1099-C. The IRS can treat canceled debt as income, but several exceptions exist. This is general information, so confirm the rules for your tax year with the IRS or a tax professional.
Why forgiven debt can be income
If you owed $10,000 and settled for $4,000, the $6,000 difference is canceled debt. Under the usual rule it counts as income in the year it is canceled. The creditor reports the amount on Form 1099-C, and the IRS gets a copy.
Common exceptions
- Bankruptcy: debt discharged in a bankruptcy case is generally not taxable income.
- Insolvency: if your total debts were more than the fair market value of all your assets immediately before the cancellation, you may exclude canceled debt up to the amount you were insolvent.
- Certain qualified debts, such as some mortgage debt on a main home, depending on the tax year and current law.
- Some student loan forgiveness programs, depending on the program and year.
- Debts that are not yours, or amounts reported in error.
How to claim an exclusion
- List all your debts and the fair market value of all your assets as of the day before the cancellation. Include retirement accounts and other assets.
- Compute whether debts exceeded assets and by how much.
- File IRS Form 982 with your return for the year of cancellation, and report the excluded amount.
- Keep your worksheet and supporting records for at least as long as the return could be audited.
- Consider a tax professional, since insolvency calculations are easy to get wrong.
If the 1099-C looks wrong
- Check the amount, the date and the creditor. Interest and fees may be included in the figure.
- Ask the creditor in writing to correct a mistaken form.
- If you were never liable for the debt or it was already paid or discharged, tell the creditor and keep copies.
- If the debt is old, a form may appear even after the time limit to sue has passed. Receiving a form does not by itself revive the debt, and a form does not always mean the creditor has legally given up the claim, so ask for a written statement of the account status.
Planning when you settle
Before accepting a settlement, ask whether a 1099-C will be issued, and estimate the tax. Setting aside money for the tax bill can avoid a second problem. Compare it with alternatives such as bankruptcy or an installment plan. See our guides on debt settlement and on bankruptcy versus settlement.
When to get help
A tax preparer or enrolled agent can model the effect on your return. Free help may be available through volunteer tax programs and low-income taxpayer clinics. If you owe the IRS, our guide to IRS payment plans covers the options.
A hypothetical insolvency check
Suppose a person settles a $12,000 credit card balance for $5,000, and a $7,000 cancellation is reported. Just before the settlement, her debts total $40,000, including the card, and her assets are worth $34,000. She was insolvent by $6,000, so she may be able to exclude up to $6,000 of the $7,000 and report the remaining $1,000 as income. The numbers depend on every asset and debt on that day, which is why the worksheet matters.
Records to keep
Save the settlement letter, proof of payment, the 1099-C, statements showing balances on the day before cancellation, and valuations for major assets. If the IRS asks about the form, these papers support the exclusion you claimed. Keep them with your tax return.
Frequently asked questions
Is settled credit card debt taxable?
Often yes, unless an exclusion such as insolvency or bankruptcy applies.
What is a 1099-C?
A form a creditor sends when it cancels $600 or more of debt.
How do I claim the insolvency exclusion?
With Form 982 and a worksheet of assets and debts.
Does a 1099-C mean I no longer owe the debt?
Not necessarily, so ask for written confirmation of the account status.
Do I need a tax professional?
It is wise when the amounts are large or insolvency is involved.