Canceled Debt as Income, and the Exceptions to the Rule

Have you had debts forgiven? To the unpleasant surprise of many, the IRS counts forgiven debt as income—meaning, it has to be reported as income on your tax return. If you’re in this situation, you’ll often receive a 1099-C Form, sent by the organization that forgave your debt.

This would occur if, for instance, you owed $5,000.00 on a credit card, and you settled the debt for $2,000.00 as settlement in full. Although that remaining $3,000.00 balance may seem to have disappeared, IRS guidelines require that you report it as ordinary income.

Not all forgiven debt is considered income, however. The main exception to this is debt discharged through bankruptcy—this debt does not need to be reported as earnings. And there are some other exceptions to this rule: If you can prove insolvency; if you’ve incurred debt directly from the operation of a farm; or if your debt was incurred through non-recourse loans. None of these need to be reported as income either.

Another important exception to the rule is foreclosure. If your debt has been forgiven through the foreclosure of your primary residence, that amount does not need to be counted as income either—the Mortgage Forgiveness Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their home.

For more information on canceled debt as income, take a look at IRS publication 4681, consult with your tax advisor, or contact an attorney here at Wagner, Falconer & Judd!

Attorney Robert J. Carlson