Does Settling a Debt Trigger a Tax Bill?

When a creditor forgives part of a debt, the IRS may treat the cancelled amount as income. Forgiveness of $600 or more is typically reported on a Form 1099-C, and you could owe tax on it.

When it's taxable

If you settle a $10,000 debt for $4,000, the $6,000 difference can be taxable cancellation-of-debt income. Plan for it before you settle so the tax isn't a surprise.

The insolvency exclusion

If your liabilities exceeded your assets when the debt was cancelled, you may exclude some or all of the income under the insolvency rules. Debts discharged in bankruptcy are generally not taxable. A tax professional can confirm what applies.