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Forgiven debt and taxes, in plain terms

When a creditor forgives $600 or more, a tax form usually follows, and the amount may count as income. The outline, including the insolvency exception, without the advice.

01The rule, roughly

Under federal rules, debt that a creditor cancels is generally treated as income to you in the year it is cancelled. The logic is that you received the money when you borrowed it and never paid it back. A creditor that forgives $600 or more in a year usually sends a Form 1099-C, and a copy goes to the IRS.

In a resolution program, each settled account can produce one. Settle a $12,000 balance for $5,500, and the $6,500 difference is what shows up on the form. Across a full program, the forgiven total can run into the tens of thousands.

02What it can mean at filing time

Cancelled debt is added to ordinary income. Someone in a 12% federal bracket with $15,000 forgiven could see roughly $1,800 added to the federal bill, plus state tax where it applies. Someone in a 22% bracket could see roughly $3,300. The forms arrive in January or February for the prior year, and they often surprise people who thought the settlement closed the matter.

The timing is per account, so a program that settles accounts across three tax years spreads the forms across three returns.

03The insolvency exception

If your total debts were larger than the value of everything you owned right before an account was forgiven, you were insolvent at that moment, and cancelled debt up to the amount of the insolvency may be excluded from income. Many people in a resolution program are insolvent at least part of the way through, because the debt is the reason they enrolled. Claiming it means working out your assets and debts as of each settlement date and filing a form with the return. Debts discharged in bankruptcy are excluded under a separate rule.

04Practical steps

  • Keep every settlement letter. It shows the original balance, the amount paid and the date, which is what the form and any exclusion are built from.
  • Expect a form from each creditor that forgave $600 or more, and check that the amount matches the letter.
  • Note your total debts and the rough value of what you own around each settlement date, while the numbers are easy to find.
  • Set aside something for the tax bill in the year each account settles, in case the exclusion does not cover all of it.

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  1. Debt resolution: the full guideWhat debt resolution is, who it fits, how a program runs month by month, what it costs in fees and credit, and where it stands against borrowing on the house.
  2. What debt resolution really costsFees run 15 to 25% of enrolled debt, charged after each settlement. Add the interest that piles up while you wait, and the savings are real but smaller than the headline.
  3. HELOC interest and taxes, in plain termsInterest on a home equity line is deductible in some situations and not in others, and the difference is what you spend the money on. The outline, without the advice.

This path, in order

Debt resolution: the full guide

  1. 01Should you use home equity to pay off card debt?Moving card balances onto the house can lower the rate. It also puts the house behind the debt. Sometimes the better move is to reduce what you owe.
  2. 02What debt resolution does to your creditScores often drop 100 points or more. Late marks and charge-offs stay 7 years. Recovery usually starts 12 to 24 months after settlements. Here is the shape of the damage and the rebuild.
  3. 03Debt resolution vs. consolidation, counseling and bankruptcyFour ways to deal with debt you cannot keep up with. What each one pays back, how long it takes, what it does to credit, and who can actually use it.
  4. 04What debt resolution really costsFees run 15 to 25% of enrolled debt, charged after each settlement. Add the interest that piles up while you wait, and the savings are real but smaller than the headline.
  5. 05Forgiven debt and taxes, in plain termsYou are here
  6. 06Which debts can go into a resolution program, and what can happen to themCards, personal loans and medical bills can be enrolled. Mortgages, car loans and federal student loans cannot. What enrolled accounts go through, from collections to a possible summons.