- Cancellation of debt refers to a creditor discharging or forgiving your outstanding balance.
- You should receive IRS Form 1099-C for canceled debt in the amount of $600 or more.
- Canceled debt could be treated as taxable income, increasing your tax bill to the federal government.
- The IRS lists exceptions for when you may not have to pay tax on canceled debt.
A cancellation of debt occurs when your outstanding balance is partially or completely discharged, perhaps if you qualified for student loan forgiveness or negotiated a debt settlement for less than you owe. Unfortunately, there’s a catch: You might receive Form 1099-C in the mail.
If you receive this official-looking IRS form bearing the phrase, “cancellation of debt,” you might think Uncle Sam is coming for his share. And while debt forgiveness in the amount of $600 or more could increase your gross, taxable income, there are exceptions to this rule, particularly for student loans or if your finances are in disrepair.
Let’s review the 1099-C document, plus scenarios where your tax bill might—and might not—be impacted.
Why you might receive Form 1099-C Cancellation of Debt
If some or all of your debt is canceled, forgiven or discharged by a lender, creditor or third-party collector, the amount you no longer have to pay could be considered income, making it taxable by the federal government. Unless the canceled debt is an exception to this rule (more on that below), you will have to account for it when filing your taxes—regardless of whether you receive a Form 1099-C.
Receiving this IRS form, though, is a clear indication that you received at least $600 worth of debt relief. Form 1099-C also lists your creditor’s information.
What if you didn't receive Form 1099-C?
If you received debt relief but not the associated Form 1099-C, contact your ex-creditor. Keep in mind, however, that you won’t receive the document for debt discharges under $600.
For cancellation of debt below $600, you’d still be required to note your forgiveness amount on Form 1040’s “other income” category. A good default, of course, is to consult a tax professional before or while filing your annual tax returns.
When you may not have to pay tax on cancellation of debt
Just because you received a cancellation of debt—or even a Form 1099-C—doesn’t necessarily mean that you’ll face a big tax bill. The IRS notes exclusions and exceptions for cases when canceled debt won’t increase your gross, taxable income. These scenarios include:
Bankruptcy: If your debt was discharged via court proceedings, confirm your tax obligations with your bankruptcy lawyer.
Farm, business property: If the debt in question was related to your agricultural business or commercial real estate, you may not have a tax obligation.
Gifts: If a family member or other benefactor canceled debt, perhaps via an inheritance, it could be treated as a gift (which isn’t taxable up to the 2022 limit of $16,000) though it's less likely you'd receive a 1099-C in this scenario.
Insolvency: If your canceled debt amount is greater than your assets, you could be off the hook with the IRS.
Student loans: Certain loan types and forgiveness programs explicitly state whether relief is tax-free or not.
“Also, in situations where a consumer brings a claim against a creditor for legal violations on a disputed debt… the forgiveness might not be subject to tax liability, as it is a settlement of a disputed claim,” says Simon Goldenberg, a debt relief lawyer in New York. “A [Certified Public Accountant] familiar with the consumer's overall financial circumstances would be the best resource to explore these methods in detail.”
Beyond these situations, it's wise to keep tabs on the news out of Congress or to pepper your tax consultant with questions about the latest in tax policy. For example, until March 2021, only certain student loans were eligible for tax-free forgiveness, such as debt forgiven via the popular Public Service Loan Forgiveness initiative. But, thanks to the coronavirus pandemic-inspired American Rescue Plan Act, all federal, private and institutional student loan forgiveness is free from the grasp of IRS tax collectors through 2025.
How can you avoid paying tax if you receive a Form 1099-C?
If you receive Form 1099-C, confirm the information listed is accurate. If your creditor erred in the forgiven amount or is still trying to collect the debt, contact them directly.
For legitimately canceled debt, you might receive Form 1099-C but still be excused from paying taxes. If you believe your canceled debt falls under one of the exceptions listed above—and therefore shouldn’t count toward your gross, taxable income—you can file Form 982 along with your return. This worksheet allows you to mark the exception that applies in your case.
Ways to pursue debt cancellation
Now that you know what cancellation of debt means and whether it could impact your tax filing, you might be wondering how to get rid of (other) outstanding balances.
The tried-and-true method of debt repayment is to create a budget, select a repayment strategy (such as the debt snowball method) and work your way toward the finish line. Receiving debt forgiveness, however, can be a part of your overall strategy, sometimes turning a marathon into a sprint.
Below are some ways to seek out a debt discharge:
Attempt a debt settlement negotiation: If you have unsecured debt, such as for credit cards or a personal loan, you might try offering a lump sum or payment plan for less than your full balance. Just keep in mind that most lenders and debt collectors won’t grant a debt settlement unless they have reason to believe you’re unlikely to repay your debt in full. Also, settlement (unlike cancellation of debt) could negatively impact your credit score in the short-term.
Examine loan forgiveness programs: There may be legitimate ways of discharging your debt that you don’t already know about. There are many existing pathways toward federal student loan forgiveness, for example, though private loan forgiveness is more limited. As you seek forgiveness programs for all types of debt, beware of scammers that promise immediate relief in exchange for your private information or upfront fees. If something sounds too good to be true, it probably is.
Consider a debt management plan: Though not cancellation of debt per se, you might be able to lower your outstanding balances on this more affordable debt repayment plan. An accredited nonprofit credit counseling agency can set you up with this plan, though it’s possible that not all of your creditors will agree to the arrangement.
Bankruptcy, as a last resort: It’s possible to discharge debt via bankruptcy, but it’s not the right move for everyone. Court proceedings would hamper your credit for years, so you might not end up with the clean slate you imagine. For now, it could be useful to compare Chapter 7 and Chapter 13 bankruptcy options.