An individual has a debt forgiven. While this may wipe out a financial obligation to a creditor, this cancellation may create a tax liability. Individuals must report debt forgiveness for the tax year in which the debt was forgiven.
In general, the IRS views the forgiven amount as taxable, ordinary income. For example, a taxpayer has $10,000 forgiven. Generally, they must report that $10,000 as income on Form 1040.
Put another way, one individual pays off the $10,000 debt from their primary income and is responsible for the taxes on that income. Another individual has that $10,000 forgiven and is responsible for the taxes on that income. In both situations, the taxpayer is responsible for paying taxes on $10,000.
Form 1099-C
After a debt is canceled, a creditor may send a taxpayer Form 1099-C, Cancellation of Debt. Taxpayers have the responsibility to ensure the amount listed is correct.
Debt Income Exceptions
Certain types of debt are exempt from being considered income. In these cases, taxpayers do not have to pay taxes on the forgiven debt.
Individuals don't have to pay taxes on the following types of forgiven debt:
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When cancellation is a gift, bequest, devise, or inheritance
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Qualified student loans that have employment-based provisions for cancellation based on a taxpayer's profession and length of employment
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Some student loans discharges between December 31, 2020 and January 1, 2026
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Under certain student loan repayment assistance programs, amounts received or forgiven
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If a canceled debt would have been deductible if the taxpayer had paid it
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When a seller gives a qualified purchase price reduction to a buyer
Student loan discharge can be especially difficult to navigate because the exclusions rely on the specific facts for each taxpayer.
Gross Income Exceptions
Individuals may also be free from tax liability for the following debt cancellations:
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In a Title 11 bankruptcy case
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To the extent a taxpayer is insolvent
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Qualified farm indebtedness
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Qualified real property business indebtedness
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Qualified principal residence indebtedness discharged or arranged before January 1, 2026
Determining when a taxpayer falls under any of these exclusions isn't always easy.
If you need help, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.
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