Quick summary

Debt forgiveness (also called debt cancellation or discharge) usually increases your taxable income, while offsets (for example, Treasury or IRS refund offsets) reduce refund payments to satisfy past-due government or other authorized debts. Each follows different rules, forms, and relief options: forgiven debt is often reported on Form 1099‑C and may be excluded in limited situations; offsets are handled through the Treasury Offset Program or state counterparts and are not “income.” (See IRS Publication 4681 and Treasury TOP for details.)

How the tax rules work in plain language

  • Creditor-issued forgiveness: If a creditor cancels or forgives a debt, they generally must file Form 1099‑C, Cancellation of Debt, and send a copy to you and the IRS. You must include the canceled amount in income on your federal return unless a statutory exclusion or exception applies. (IRS: Form 1099‑C and Publication 4681.)
  • Common exclusions: Exceptions include bankruptcy discharges, insolvency at the time of cancellation (partially or fully), certain student loan discharges (tax-free through 2025 under the American Rescue Plan Act for qualifying discharges), and other limited statutory exclusions. When you qualify for an exclusion, you normally file IRS Form 982 to reduce tax attributes rather than report the canceled amount as income. (IRS Pub. 4681; IRS Form 982.)
  • Offsets vs. forgiveness: An offset — such as the IRS reducing your refund to pay child support or past-due federal student loans via the Treasury Offset Program — is a collection action, not taxable income. Offsets lower the refund you receive; they do not produce a 1099‑C. (U.S. Department of the Treasury TOP information; IRS Tax Topic on offsets.)

Sources: IRS Publication 4681 (Cancellation of Debt) https://www.irs.gov/publications/p4681; About Form 1099‑C https://www.irs.gov/forms-pubs/about-form-1099-c; Treasury Offset Program https://fiscal.treasury.gov/top/.

Typical scenarios and what to expect

  • Credit card or medical debt settlement: If you settle for less than the full balance, the forgiven portion is generally taxable and reported on Form 1099‑C. You should determine if you were insolvent at the time of the discharge (assets < liabilities), because insolvency can exclude some or all of the canceled amount. Use Form 982 to claim that exclusion.

  • Mortgage principal reduction or short sale: Mortgage forgiveness used to qualify under special principal-residence exclusions in some past years; most temporary relief provisions have expired, so check current IRS guidance. If the lender reports canceled principal on Form 1099‑C, treat it like other discharged debt unless a specific exclusion applies.

  • Business loan forgiveness (including PPP): Pay attention to the loan type. Paycheck Protection Program (PPP) loan amounts forgiven are not taxable to the borrower, and Congress allowed related business expenses to be deductible for federal purposes. Other commercial loan forgiveness is generally taxable. Verify the loan program’s rules and IRS statements.

  • Student loans: The American Rescue Plan Act of 2021 made certain discharges of federal student loans tax-free through December 31, 2025. Private student loan discharges still typically follow the general canceled-debt rules unless specifically excluded. Check current IRS guidance for qualifying discharges.

  • Offsets for federal debts: If the IRS or Treasury offsets your tax refund for student loans, child support, or other federal obligations, you should receive notice. Offsets can also be applied across agencies and states via the Treasury Offset Program.

What you should do when you receive a 1099‑C or notice of offset

  1. Don’t ignore the form or notice. A 1099‑C typically arrives late in the year and triggers a reporting obligation. An offset notice usually arrives as a letter explaining the debt and the agency requesting collection.
  2. Verify amounts and timeline. Compare the 1099‑C with your records (payment history, settlement agreement). For offsets, confirm the debt, agency, and that the offset was authorized.
  3. Evaluate exclusions. Determine if bankruptcy, insolvency, qualified student loan exclusion, or other rules apply. If you qualify for an exclusion, you generally complete Form 982 and attach it to your tax return. (See Form 982 instructions.)
  4. If insolvent, calculate the insolvency amount using IRS worksheets before reporting the canceled debt as income.
  5. Consider estimated tax/withholding changes. A large forgiven amount can push you into a higher tax bracket or increase quarterly estimated tax payments; plan accordingly.
  6. When facing an offset, follow the dispute process quickly. The notice will tell you where to appeal or request a review; Treasury TOP and the creditor agency provide steps to dispute errors.

Authoritative IRS references: Form 982 https://www.irs.gov/forms-pubs/about-form-982; Form 1099‑C https://www.irs.gov/forms-pubs/about-form-1099-c; Publication 4681 https://www.irs.gov/publications/p4681.

Practical examples (illustrative)

  • Example 1 — Credit card settlement: You owe $12,000, settle for $6,000, and receive a Form 1099‑C for $6,000. If you were insolvent and your liabilities still exceeded assets by $5,000 at the time, $5,000 of the canceled debt may be excluded; you would report the remaining $1,000 on your return unless another exclusion applies.

  • Example 2 — Refund offset: You are due a $1,500 federal refund but have a past-due child-support order; the IRS reduces your refund and sends $1,200 to the child-support agency while you receive $300. You’ll get a notice explaining the offset and how to dispute it if you believe it’s wrong.

Note: These examples are simplified and for education. Exact tax treatment depends on individual facts.

Common mistakes I see in practice

  • Ignoring a 1099‑C or delay in checking mail; by the time taxpayers notice the form, they may miss filing adjustments or pay unexpected tax bills.
  • Failing to calculate insolvency properly — debtors either overreport taxable income (paying more than required) or underreport and risk audit adjustments.
  • Assuming an offset is taxable income — it isn’t. But people often misread offset notices and confuse collection with cancellation.
  • Not checking state tax rules. Some states do not follow federal exclusions; forgiven debt excluded federally may still be taxable at the state level.

In my practice I routinely recommend keeping settlement documents and sending them to your tax preparer before filing. That paperwork is often decisive in applying exclusions.

How to dispute or get help

  • For potentially incorrect 1099‑C amounts: Contact the creditor first and request correction if it’s wrong. If the creditor refuses and you believe the 1099‑C is wrong, consult a tax professional about documenting your position and filing returns with an attached explanation.
  • For offsets: Follow the instructions on the offset notice. If the Treasury Offset Program applied a reduction in error, you can request a review from the agency that requested the offset and from Treasury TOP.
  • When in doubt, work with a CPA or tax attorney. They can prepare the insolvency worksheet, file Form 982, and represent you before the IRS.

Where to read the rules and next steps

For related FinHelp coverage, see our guides on Tax Reporting After Loan Forgiveness: Forms and Pitfalls and How Refund Offsets Work: When the IRS Keeps Your Refund. These pages walk through common forms, sample letters, and timing issues.

Bottom line

Debt forgiveness can create taxable income with specific exclusions and reporting obligations; offsets reduce your refund to satisfy debts and are a collection action, not income. Prompt review of documents, timely appeals of offsets, and early coordination with a tax professional can reduce surprise tax bills and cash‑flow shocks.

Professional disclaimer: This article explains general U.S. federal tax rules as of 2025 and is educational only. It is not individualized tax advice. For advice about your situation, consult a qualified CPA, enrolled agent, or tax attorney.