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You could face a tax bill if your debt is forgiven—here's what you need to know

Having debt forgiven can be great, but you could get a large tax bill. Here's what you need to know.

Oliver Rossi/Getty Images
Select’s editorial team works independently to review financial products and write articles we think our readers will find useful. We earn a commission from affiliate partners on many offers, but not all offers on Select are from affiliate partners.

Roughly one in three Americans have delinquent debt according to recent data from The Urban Institute. At 16%, medical debt makes up the highest percentage of debt delinquency, but consumers also default on student loans, auto loans and credit card debt.

If someone's debt is so large that making payments becomes unmanageable (or if paying off the balances would take an unthinkable number of years), consumers may be able to find relief through debt settlement.

Debt settlement companies help consumers negotiate their debts down, either with the original lender/card issuer or with a collections agency. This gives people who are in over their heads a chance to clear away their balances at a lower cost.

In exchange for a professional fee, debt settlement professionals (often lawyers) advocate on behalf of their clients to convince lenders to agree to a lump-sum settlement amount that absolves the borrower of outstanding debt. 

Lenders are under no obligation to accept these settlement proposals, but they often do it to cut their losses and recoup expenses. Meanwhile, clients benefit from having their debt essentially wiped away for much less than the original balance. However, when you have a significant portion of debt forgiven, the IRS collects taxes on the difference between what was owed and what was actually paid. 

"You will be taxed on any forgiven debt over $600," explains Leslie H. Tayne, a debt-relief attorney and founder of Tayne Law Group. "There are some exceptions," she tells Select, "but even if you do end up paying taxes on [the forgiven debt], you'll generally still be better off than if you had to pay the full sum."

Below, Tayne tells Select how debt forgiveness works, what kind of debt is taxable and how debt relief appears on your credit report.

How debt forgiveness works

Debt settlement, or debt forgiveness, is a last-resort option that can help debtors get out from under overwhelming balances. The process can take a few years, but when it's successful debtors can pay off their debt for less than they actually owe. However, it's important to be realistic about what debt forgiveness can offer you.

It's rare that debt settlement will let you off the hook for five-figure sums unless you can prove severe hardship, says Tayne. For instance, if you owed $30,000 in credit card debt and only offer to pay $10,000, it's unlikely that your lender would accept this debt settlement offer. And as Tayne learned by defaulting on her own student loans, by the time it becomes necessary to negotiate debt settlement, you've usually paid far more in interest and late fees than you would have if you had made your monthly payments from the beginning

Nonetheless, debt forgiveness is a viable option when you have few other choices. Similar to working with a credit counselor, debt settlement professionals speak directly with your lenders on your behalf. But according to the CFPB, debt settlement has a reputation for being riskier than credit counseling because debt settlement lawyers negotiate with your lenders to get them to accept less than you owe. Meanwhile, nonprofit credit counselors tend to focus more on educational services including budgeting, saving and developing an individual debt payoff strategy.

In both cases, check out the debt relief firm or organization with your state Attorney General and local consumer protection agency to learn if any consumer complaints are on file. For an extra layer of protection, you can find out if debt relief companies must be licensed to work in your state and confirm that the company you're working with has appropriate credentials.

Most canceled debt is taxable

If you are able to get a settlement that's significantly less than your total debts owed, you will be taxed on any forgiven debt over $600. 

"The creditor is required to file a 1099-C form with the IRS, which will detail the amount of your settled debt," says Tayne. And similar to income tax forms, you will also receive a copy of the 1099-C forgiveness of debt form from the forgiving creditor in the tax year the final payment is made.

"That form will give you the amount forgiven," says Tayne, which is the amount that's considered taxable income. There is a specific line for this purpose on your tax forms.

There are some exceptions and exclusions to this rule, which are outlined below. But even if you do end up paying taxes on your forgiven debt, "you'll generally still be better off than if you had to pay the full sum," Tayne argues.

Some canceled debt is exempt

In some cases, canceled or forgiven debts can be eliminated from your taxable income. These are considered exceptions. Other kinds of debt may be lowered or reduced, but not outright eliminated. The IRS calls these kinds of debts exclusions. When you fill out your tax forms, exceptions are applied before exclusions.

Below, we outline what kinds of debt forgiveness is not considered taxable, according to the IRS.


Taxpayers might be able to eliminate the following types of canceled debt from their taxable income:

  • Gifts and bequests
  • Certain student loans (e.g., doctors, nurses, and teachers serving in rural or low-income areas)
  • Deductible debt (e.g., home mortgage interest that would have been deductible on Schedule A)
  • Price reduced after purchase (e.g., debt on solvent taxpayer's property is reduced by the seller; basis of property must be reduced)


Some types of debt may be lowered or reduced, but they must be filed as an exclusion using Form 982. They are:

  • Discharge of debt through bankruptcy
  • Discharge of debt of insolvent taxpayer
  • Discharge of qualified farm indebtedness
  • Discharge of qualified real property business indebtedness
  • Discharge of qualified principal residence indebtedness

When navigating these exemptions and exclusions, be sure to work with a certified tax professional with experience in debt settlement.

How debt forgiveness shows up on your credit report

The details of your debt forgiveness plan will not show up on your credit report, says Tayne. What was once delinquent debt will simply show up as "settled," rather than "paid in full." When employers and lenders do a hard pull of your credit history, they won't see any details beyond this.

Debt settlement can also actually help your credit score in the long run, because you're no longer delinquent on payments and the debt is cleared. 

"Your credit may be temporarily damaged, but it will come back up quickly," Tayne says. "Generally, it does work out in the debtor's favor to settle the debt, especially if simply paying it off isn't really an option."

Other options for paying off debt

Debt settlement can be a lifesaver for people who feel buried by their credit card bills, but there are some other options if you simply need to get a better handle on your payments.

Paying off credit card debt with a balance transfer card or a debt consolidation loan is generally less risky than debt settlement when you do your research beforehand. Pairing a 0% APR credit card with either of the time-tested snowball or avalanche methods might be quicker and end up saving you more money.

Balance transfers typically charge fees between 2% and 5%, unless you're approved for a no-fee balance transfer card. For instance, the Citi® Double Cash Card charges an intro balance transfer fee of 3% of each transfer (minimum $5) completed within the first four months of account opening. After that, your fee will be 5% of each transfer (minimum $5).

The Citi Double Cash Card requires good to excellent credit to qualify. However, the Aspire Platinum Mastercard is a balance transfer card where applicants with fair credit have a better chance of qualifying. Its promotional interest period is shorter than most cards, at six months, but even a short no-interest period could help you get ahead if your interest is high. If you aren't able to pay your balance off entirely before the introductory 0% APR period ends, the variable interest rate is relatively low, at 8.15% to 18.00%. 

Bottom line

Delinquent debt can impact your credit history, but working with a debt settlement professional is one way to move on from the past. You can settle your debt for less than you originally owed, but you will have to claim the forgiven amount as taxable income. 

Choosing to settle your debt is a personal decision that's based on your financial situation. It depends on the amount and kind of debt you have, your current and future income and what kind of assets you have in your name. Never offer to settle your debt unless you can follow through with a lump-sum payment. If you're struggling to meet your minimum payments or have had debt go to collections, search for a local debt-relief lawyer or debt professional with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies.

Information about the Aspire Platinum Mastercard has been collected independently by Select and has not been reviewed or provided by the issuer of the card prior to publication.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.