Tax Consequences When a Creditor Writes Off a Debt

If you should ever have a debt declared uncollectible or settled for less than the full amount, chances are you will have to pay taxes on your forgiven debt.

After a set amount of time, such as two or three years after you default on payments, a creditor will eventually cease collection efforts and declare the debt to be uncollectible to ease their tax burden. When debt reductions are negotiated, any amount that is unpaid will be reported as lost income to the IRS. If you settle a debt with a creditor for less than the full owed amount, or if a creditor writes off a debt you owe, you will have to report it to the IRS as taxable income. This rule applies for nearly any type of debt write-off or forgiveness, including foreclosures and property repossessions.

Any financial institution or creditor that forgives or writes off $600 or more of your outstanding debt must send you and the IRS a Form 1099-C at the end of the tax year. You will be required to include this document with your tax return. If your debt was less than $600 and you did not receive a 1099-C, you will still be required to indicate this write off in your return. If you do not reveal this write off to the IRS, you could receive a bill or a possible audit notice as a result.

You will not have to reveal this income if:

• The debt was a nonbusiness debt and was canceled in the aftermath of Hurricane Katrina
• A student loan was forgiven because you worked in a profession and employer as promised
• The debt was discharged during bankruptcy
• A debt write-off or cancellation is given as a gift
• The written-off debt would have been deductible if paid
• You filed for insolvency before the debt was settled or written off

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