Overview

When you settle a debt for less than the balance owed, the amount forgiven can be treated as taxable income by the IRS. Creditors are required to file Form 1099‑C, Cancellation of Debt, for many discharges of $600 or more (see IRS guidance on Form 1099‑C). That reported amount is usually includible in your gross income unless a statutory exclusion applies.

How lenders report forgiven debt

  • Form 1099‑C: Creditors normally send Form 1099‑C to both the borrower and the IRS when they cancel qualifying debt amounts. The form shows the amount of debt discharged and the date of discharge. (IRS, Topic No. 431 and Form 1099‑C instructions.)
  • Filing threshold: The common reporting threshold is $600, but even if you don’t receive a 1099‑C, you may still be required to report canceled debt on your tax return.

Key exclusions that can prevent tax on forgiven debt

  • Bankruptcy discharge: Debts discharged through a Title 11 bankruptcy proceeding are not taxable. You generally exclude that canceled debt from income and report it per IRS rules (see Form 982).
  • Insolvency: If your total liabilities exceeded your total assets immediately before the discharge, you may exclude some or all of the forgiven amount. The IRS explains how to calculate insolvency and how to claim the exclusion on Form 982.
  • Other special rules: Certain types of forgiveness—such as some qualified farm indebtedness, qualified real property business indebtedness, or discharge under specific federal programs—have separate rules. Student loan discharges and some mortgage-related relief also have distinct treatments; check the IRS guidance for details.

Practical example

If you owed $10,000 and a creditor accepted $4,000 in settlement, the creditor may report $6,000 as canceled debt on Form 1099‑C. That $6,000 is ordinarily taxable income unless an exclusion applies. If you were insolvent by $5,000 immediately before the discharge, you could exclude up to that $5,000 by following the Form 982 instructions; the remaining $1,000 would be taxable.

What to do if you receive a Form 1099‑C

  1. Review the form and settlement paperwork to confirm amounts and dates.
  2. Determine exclusions: calculate insolvency or confirm bankruptcy status.
  3. Use Form 982 to claim an exclusion (and follow the form instructions).
  4. Report any remaining taxable amount on your federal income tax return.
  5. Keep complete records of the settlement agreement, correspondence, and financial statements used for insolvency calculations.

Common mistakes and misconceptions

  • “I didn’t get a 1099‑C, so I don’t have to report it.” You still must report canceled debt as income if it’s taxable—even without a form. (IRS Topic No. 431.)
  • “All forgiven debt is taxable.” Not always—bankruptcy and insolvency are common exclusions, and some types of forgiveness are statutorily excluded.
  • Miscalculating insolvency: Insolvency is based on assets vs. liabilities immediately before the discharge. Don’t mix pre- and post-discharge balances.

Actionable tips

  • Consult a tax pro: Debt settlement can have complex tax consequences. In my 15 years advising clients, I’ve seen small calculation errors lead to unexpected tax bills—get professional help for larger settlements.
  • Save documentation: Keep settlement letters, account ledgers, bank statements, and any notices of discharge.
  • Use IRS resources: Review IRS Topic No. 431 (Cancellation of Debt), the Form 1099‑C page, Form 982 instructions, and Publication 4681 for foreclosure and canceled debt rules.

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Professional disclaimer

This article is educational and not personalized tax advice. Tax rules change and individual situations vary—consult a qualified tax professional or the IRS before relying on this information.

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