Overview
Loan forgiveness becomes taxable income when the amount of debt canceled is treated by the IRS as income you received but no longer must repay. Creditors usually report canceled debt on Form 1099‑C; that information is also sent to the IRS and can trigger a tax liability if no exclusion applies (IRS — About Form 1099‑C: Cancellation of Debt).

How the IRS treats canceled debt

  • Reporting: If a creditor cancels a debt, it commonly issues Form 1099‑C to you and the IRS. You must report the canceled amount on your federal return unless you qualify for an exclusion or exception (see IRS Topic: Cancellation of Debt and Form 982).
  • Forms to use: If an exclusion applies (for example, insolvency or bankruptcy), you generally show the exclusion on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (IRS — Form 982 instructions).

Common exclusions and when they apply

  • Bankruptcy discharge: Debts discharged in a Title 11 bankruptcy case are not taxable (report exclusion on Form 982).
  • Insolvency: If your total liabilities exceeded assets immediately before the discharge, you may exclude some or all of the canceled debt under the insolvency exclusion. You’ll need documentation of assets and liabilities.
  • Certain student‑loan discharges: Some federal student‑loan cancellations—such as discharges for death, disability, closed school, and many public‑service loan relief programs—are generally excluded from taxable income. The American Rescue Plan Act (ARPA) also excluded certain federal student loan discharges from income for tax years through 2025; check current IRS guidance for program specifics (IRS — Cancellation of Debt).
  • Temporary or program‑specific relief: Forgiveness under programs like PPP has received special federal treatment; for example, PPP loan forgiveness is not treated as taxable income at the federal level, though state tax treatment can differ (see our guide on PPP loan forgiveness tax considerations).

Situations that commonly create taxable income

  • Credit card or personal loan forgiveness outside bankruptcy or insolvency rules.
  • Lender‑agreed settlements where a portion of the principal is canceled and none of the statutory exclusions apply.
  • Mortgage debt forgiven outside of a qualifying exclusion—unless covered by a specific law or exception—may be taxable.

What to look for and steps to take

  1. Watch for Form 1099‑C: If you receive it, don’t ignore it. The amount listed is what the IRS will expect to see unless you have and document an exclusion. (IRS — About Form 1099‑C)
  2. Check Form 982 if you think an exclusion applies: Use it to report bankruptcy, insolvency, or other allowable exclusions.
  3. Gather records: Statements, settlement letters, bankruptcy papers, and valuations that prove insolvency or other bases for exclusion.
  4. Consider state tax rules: Some states tax forgiven debt differently from the federal government. See our state vs federal guide for specifics. (When Loan Forgiveness Is Taxable: State and Federal Differences)
  5. Consult a tax professional: In my practice, small documentation issues or incorrect assumptions about exclusions frequently cause errors on returns. A tax advisor can help you determine whether you owe tax and how to report it accurately.

Real‑world example (practice insight)
A client had $15,000 of medical debt canceled after negotiating with a collection agency. The creditor issued a 1099‑C. Because the client’s assets exceeded liabilities, the insolvency exclusion did not apply, and the canceled amount increased their taxable income for that year. Proper documentation and upfront tax planning could have reduced the surprise.

Resources and links

Common mistakes to avoid

  • Assuming all student‑loan forgiveness is automatically tax‑free. Program rules vary.
  • Failing to report a 1099‑C even when you intend to claim an exclusion—timely reporting with Form 982 is crucial.

Disclaimer
This entry is educational and not tax advice. For advice tailored to your situation, consult a CPA or tax attorney.