Quick overview

When a creditor cancels or forgives a debt, the IRS generally treats the amount of the cancelled debt as taxable income to the borrower. Creditors use Form 1099‑C, Cancellation of Debt, to report the amount to the IRS and to the borrower when $600 or more of debt is cancelled. That form is a trigger — not the final answer — for whether you actually owe income tax on the forgiven amount. (See IRS Form 1099‑C and Topic No. 431.)

Authoritative sources: IRS Form 1099‑C (pdf), IRS Topic No. 431: Canceled Debts, and the IRS guidance page on canceled debt taxation.

This article explains how COD income is calculated, common exclusions (bankruptcy, insolvency, other rules), steps to verify or dispute a 1099‑C, and practical filing steps including Form 982.

How cancelled debt becomes taxable income

  • The cancelled amount is generally ordinary income: If you negotiated with a creditor and they agreed to accept less than you owed, the forgiven portion is usually reported as income on your federal return for the year the cancellation becomes an «identifiable event» (the date shown in Box 4 of Form 1099‑C). See IRS Form 1099‑C instructions.

  • Tax-year timing: The debt is taxable in the year the identifiable event occurs (for example, a creditor files a 1099‑C or repossession/foreclosure is completed, depending on the situation).

  • Exceptions and special treatment exist for certain debts (discussed below).

Common exclusions and when cancelled debt is not taxed

1) Bankruptcy

  • Debts discharged through a Title 11 bankruptcy are generally not taxable. The discharge of indebtedness in bankruptcy is excluded from gross income. To claim this exclusion on your return, you generally file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach any required documentation. (See Form 982 instructions and IRS Topic No. 431.)

2) Insolvency

  • Insolvency occurs when your total liabilities exceed the fair market value of your total assets immediately before the debt cancellation. If you are insolvent at that time, you may exclude cancelled debt from income up to the amount by which you are insolvent. You must prepare an insolvency worksheet showing assets and liabilities and attach Form 982 where required. Example: If liabilities are $50,000 and assets $30,000 immediately before cancellation, you are $20,000 insolvent — up to $20,000 of cancelled debt can be excluded.

3) Nonrecourse loans, foreclosures and repossessions

  • Special rules apply to nonrecourse loans. When a nonrecourse mortgage is foreclosed, the lender’s holding of the property usually results in the borrower being treated as having sold the property, not as having income from cancelled debt. The tax result is generally a sale or disposition for tax purposes, which can create capital gain or deductible loss — not COD income.

4) Certain student loan forgiveness programs

  • Some types of student loan forgiveness (for example, Public Service Loan Forgiveness) are not taxable. Others may be taxable; verify program terms and current IRS guidance.

5) Other specific statutory exclusions

  • There are limited statutory exclusions (rare or temporary) enacted by Congress at specific times. Confirm current law before relying on a temporary exclusion.

Form 1099‑C: what it shows and why it matters

  • Boxes on Form 1099‑C include the amount of debt cancelled, date of identifiable event, and the creditor’s information. Box 2 shows the amount cancelled; Box 4 shows the date of the identifiable event. Review these carefully and compare them with your records.

  • A creditor must file Form 1099‑C with the IRS and send a copy to you when it cancels $600 or more of your debt (exceptions exist — see IRS instructions).

  • Even if you don’t get a 1099‑C, you are responsible for reporting taxable COD income. Lack of a 1099‑C does not necessarily mean the income is not taxable.

Practical steps if you receive a 1099‑C

1) Don’t panic — read it carefully. Confirm the amount and the identifiable event date.

2) Gather documentation. Collect settlement letters, payoff statements, ledgers, and correspondence showing the cancellation terms.

3) Determine whether an exclusion applies. Check bankruptcy discharge records, insolvency status at the time of cancellation, nonrecourse status, and any program-specific exemptions.

4) Use Form 982 when applicable. If you qualify for the bankruptcy or insolvency exclusion (or any other listed exclusion), complete and attach Form 982 to your return to report the exclusion and reduce tax attributes as required. See Form 982 and its instructions: https://www.irs.gov/forms-pubs/about-form-982

5) If the 1099‑C is wrong, contact the creditor immediately. Ask for a corrected form and for written documentation of the reason the debt was cancelled. If the creditor refuses or disputes the facts, get tax or legal help before filing. Keep a dated record of all communications.

6) If you still disagree after contacting the creditor, you can include an explanation with your tax return and file based on your records; however, be prepared to substantiate your position if the IRS questions the return.

Example: How the insolvency exclusion works (simple numeric example)

  • You had taxable debts of $25,000 and assets worth $5,000 immediately before a creditor forgave $10,000.
  • Liabilities ($25,000) minus assets ($5,000) = $20,000 insolvency.
  • Forgiven debt $10,000 is fully excluded because your insolvency amount ($20,000) is greater than the cancelled amount.
  • You still must document the calculation and file Form 982 if the exclusion is claimed.

Common mistakes and red flags

  • Ignoring the form. You must investigate a 1099‑C — not all reported cancellations are taxable, but many are.

  • Failing to compute insolvency correctly. Don’t forget to include all assets (cash, retirement account balances where taxable on distribution, property FMV) and liabilities (priority tax debts, other loans) when calculating insolvency.

  • Overlooking nonrecourse/foreclosure rules. Treating a foreclosure incorrectly as COD income can cause errors.

  • Not getting professional help for complicated situations (business debt cancellations, cross-border issues, or large amounts).

Disputes: what to do if you believe the 1099‑C is incorrect

1) Contact the creditor in writing and request a corrected Form 1099‑C.
2) Keep copies of settlement agreements and payoff records and document all communications.
3) If the creditor won’t correct the form, prepare to file based on your facts and include a clear explanation with your return. You may need to amend a filed return later if a corrected 1099‑C arrives.
4) If the IRS audits or sends a CP2000 or related notice, respond promptly with documentation. Consider hiring a tax professional or attorney.

Recordkeeping and timing

  • Keep settlement statements, ledgers, bankruptcy discharge orders, and any insolvency worksheets for at least three years (longer if the situation was complex or IRS correspondence continues).

  • If the cancellation was part of a business arrangement, reporting and attribute reduction rules can be more complex — keep detailed records.

How this interacts with state taxes

  • State treatment of cancelled debt can differ from federal treatment. Some states follow federal exclusions; others do not. Check your state revenue department rules or ask a tax professional.

Interacting topics and further reading

Final checklist after receiving a 1099‑C

  • Verify the amount and identifiable event date.
  • Collect evidence: settlement letter, payoff, ledger, discharge/foreclosure documents.
  • Run an insolvency calculation if you think you were insolvent.
  • File Form 982 if excluding the cancelled debt due to insolvency or bankruptcy, and attach required documentation.
  • Contact the creditor for corrections if information is wrong.
  • Consider a tax professional for complex or high‑dollar situations.

Professional disclaimer: This article is educational and not individualized tax advice. Tax law changes over time; confirm current rules with the IRS (links above) and consult a qualified tax advisor for decisions that affect your situation.

Author note: In my practice I’ve seen clients avoid unnecessary tax bills by documenting insolvency and using Form 982 correctly; conversely, failing to address a 1099‑C promptly often creates avoidable penalties and interest. Timely documentation and professional help matter.