Do I Have to Pay Taxes on Reduced Debt?
When you reduce your debt through debt relief (also called debt settlement), the IRS may consider the forgiven amount as taxable income. For example:
If you owe $10,000 and settle for $5,000, the $5,000 forgiven could be treated as income on your tax return.
Why Is Forgiven Debt Taxed?
The IRS views forgiven debt as a financial benefit because it’s money you borrowed but no longer have to repay. Essentially, the forgiven portion is considered "income."
When Will I Owe Taxes on Forgiven Debt?
You may owe taxes on forgiven debt if:
The forgiven amount is $600 or more.
Your creditor reports the forgiven amount to the IRS by issuing Form 1099-C.
You don’t qualify for an exception, such as insolvency or bankruptcy.
Important: Form 1099-C will come from your creditor, not from Relief. You will not find it in the app, so be sure to check your mail during tax season.
How Does Insolvency Work?
Insolvency means that your total debts were greater than your total assets at the time the debt was forgiven. If you were insolvent, you may not need to pay taxes on some or all of the forgiven amount.
Here’s how to figure it out:
Step 1: Add Up Your Total Debts
Include all your liabilities:
Credit card balances
Personal loans
Medical bills
Collections
Any other outstanding debts
Step 2: Add Up Your Total Assets
Include everything you own with a measurable value:
Bank account balances
Vehicles (current market value)
Real estate (current market value)
Retirement accounts (401k, IRA)
Investments (stocks, bonds, etc.)
Personal property (electronics, furniture, etc.)
Step 3: Compare Your Debts to Your Assets
Subtract your total assets from your total debts.
If your debts are greater than your assets, you are insolvent.
Example:
Total Debts: $15,000
Total Assets: $10,000
Insolvency Amount: $5,000
In this case, you could exclude up to $5,000 of the forgiven debt from being taxed.
Step 4: File IRS Form 982
If you’re insolvent, you need to file Form 982 with your tax return to claim this exemption.
For more details, refer to:
What Should I Do If I Receive Form 1099-C?
If you receive Form 1099-C from your creditor:
Review the Form: Confirm the forgiven amount and creditor details are accurate.
Determine Insolvency: Use the steps above to compare your total debts and assets.
Include It on Your Tax Return: If no exemption applies, report the forgiven amount as “Other Income” on your return.
File IRS Form 982: If you were insolvent, file Form 982 to exclude the forgiven amount from your taxable income.
Are There Other Exceptions to Taxing Forgiven Debt?
Yes, aside from insolvency, you may not owe taxes on forgiven debt if:
Bankruptcy
If the debt was discharged through bankruptcy, it’s not considered taxable income.
Certain Student Loans
Forgiven student loans under programs like Public Service Loan Forgiveness (PSLF) or income-driven repayment plans are tax-exempt.
Gifted Debt
If the debt is forgiven as a gift (rare, but possible), it’s not taxable.
How Can I Prepare for Potential Taxes on Forgiven Debt?
To avoid surprises:
Set Money Aside: If you expect a significant debt reduction, prepare for potential taxes on the forgiven amount.
Track Form 1099-C: Keep an eye out for the form from your creditor.
Consult a Tax Professional: A tax advisor can help you determine insolvency and file the necessary forms.
Does Relief Handle Tax Reporting?
Relief simplifies the debt reduction process, but we do not issue tax forms or handle tax reporting. If you settle a debt through Relief, the 1099-C will come directly from your creditor.
We recommend consulting a tax professional to ensure you understand your specific situation and any exemptions that may apply.
Key Takeaway
While forgiven debt may be taxable, you could avoid paying taxes if you qualify for exceptions like insolvency or bankruptcy.
If you receive Form 1099-C:
Review the form carefully.
Use the insolvency calculation to determine if you qualify.
File IRS Form 982 if needed.
For additional details, check out:
By understanding these rules and planning ahead, you can confidently navigate the tax implications of debt relief.