Overview

When a lender forgives or cancels business debt, the canceled amount is generally treated as taxable income to the borrower for the year the debt is discharged. Lenders normally report cancellation of $600 or more on Form 1099‑C and must furnish a copy to the borrower; the borrower must then reflect the canceled debt on the appropriate business tax return for that year. (See IRS Topic No. 431 and the Form 1099‑C instructions: https://www.irs.gov/taxtopics/tc431; https://www.irs.gov/instructions/i1099c.)

Key forms and deadlines

  • Form 1099‑C, Cancellation of Debt: Lenders generally file with the IRS and send the debtor a copy for canceled debt of $600 or more. (See IRS Form 1099‑C instructions.)
  • Business tax return: Report the income on the entity’s return in the year of cancellation — e.g., Schedule C for a sole proprietor, Form 1120 for a C corporation, Form 1065 for a partnership, or on the pass‑through owners’ returns when applicable.
  • Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness: Used when claiming an exclusion for discharged debt that requires reducing tax attributes (see Form 982 instructions on IRS.gov).
  • Deadlines: Lenders must furnish the 1099‑C to the debtor by January 31 and file with the IRS by the calendar deadlines in the Form 1099‑C instructions (paper and electronic filing dates differ).

Common exclusions and special rules

  • Bankruptcy: Debt discharged in a Title 11 bankruptcy case is excluded from income under IRC §108(a)(1)(A).
  • Insolvency: A borrower whose liabilities exceed assets immediately before the discharge can exclude canceled debt to the extent of insolvency (IRC §108(a)(1)(B)); taxpayers use Form 982 to report qualified exclusions and calculate reductions to tax attributes.
  • Qualified farm or real property debt: Special rules may apply for qualified farm indebtedness or business real property under §108(c).
  • PPP and pandemic‑era programs: Paycheck Protection Program (PPP) loan forgiveness is not treated as taxable income under the CARES Act and subsequent legislation; PPP‑forgiven amounts are generally excluded from income (and related deductions were addressed by later legislation). Confirm program specifics for any government relief program.

Practical steps for businesses

  1. Don’t assume the 1099‑C is correct — verify the amount and date of discharge against loan documents and settlement agreements.
  2. Determine whether an exclusion applies: evaluate bankruptcy status, insolvency (prepare an assets vs. liabilities calculation), or program‑specific exclusions such as PPP.
  3. Use the correct tax return and attach Form 982 when required. Corporations and partnerships have different reporting mechanics — involve a CPA if the discharge affects tax attributes.
  4. Keep detailed records: lender statements, settlement agreements, balance sheets before and after discharge, and correspondence.
  5. Check state tax treatment: states don’t always follow federal exclusions; some treat discharged debt differently for state taxable income.

Common pitfalls to avoid

  • Failing to report: Ignoring a 1099‑C or canceled debt can trigger IRS notices, penalties, and interest.
  • Misapplying exclusions: Incorrectly claiming insolvency or miscalculating asset/liability amounts is a frequent error; document calculations and assumptions.
  • Overlooking program rules: Government loan forgiveness (e.g., PPP) follows specific statutory rules — don’t rely on general canceled‑debt rules without confirming program guidance.
  • Missing deadlines or filing the wrong forms: Use Form 982 when necessary and file returns for the correct tax year.

If you disagree with a 1099‑C

Contact the lender immediately to request correction if the amount or discharge date is wrong. If the lender won’t correct an incorrect 1099‑C, keep documentation and file your tax return showing the correct treatment with an explanation attached; consider seeking professional representation if the IRS raises questions.

Example (brief)

A small retail owner settles a $50,000 loan for $20,000. The lender issues a 1099‑C for $30,000 (the canceled amount). The owner must report $30,000 as income unless an exclusion applies (for example, insolvency). If the owner qualifies for an insolvency exclusion up to $25,000, only $5,000 would be taxable; the owner would document the insolvency calculation and file Form 982 as required.

Where to learn more and internal resources

Professional disclaimer

This article is educational and does not replace personalized tax advice. The rules for discharged debt can be complex and fact‑dependent — consult a CPA or tax attorney for guidance specific to your situation.

Author note

In my experience advising small businesses, careful documentation and early consultation with tax counsel when negotiating settlements or loan forgiveness can prevent surprises and reduce audit risk.