Settlement Taxation

Forgiven Debt

• Forgiven debt encompasses any debt for which the creditor waived your liability to repay. For example, if you originally owed $2,500 to your credit card company, and your creditor offered you a settlement of $800, the total amount of your forgiven debt is $1,700. The Internal Revenue Service excludes discounts, reduced interest rates and awards applied towards your debt that lowers your overall liability as forgiven debt for settlement taxation purposes.
  
  

Requirements

• Any debt settlement that results in $600 or more of forgiven debt is subject to taxation. The $600 minimum applies to all forgiven debt but not each individual debt settlement. If you accepted multiple debt settlements, and each individual settlement resulted in forgiven debt totaling less than $600, but the combined total of forgiven debt exceeds $600, you must report and pay taxes on all of your forgiven debt. If your total forgiven debt totals less than $600 for any given year, you are not required to report it.
  
  

Reporting Settlements

• Creditors use Form 1099-C (Cancellation of Debt) to report forgiven debt to the IRS. You should receive a Form 1099-C from each creditor from whom you received a debt settlement that resulted in forgiven debt. If you do not receive a Form 1099-C, contact the creditor to request one or call the IRS individual taxpayer assistance line for assistance.
  
  

Filing Taxes

• To file taxes on your debt settlement, you must report your forgiven debt on your income tax return using Form 1040. Calculate the total amount of forgiven debt from all 1099-C forms you receive, and then enter this amount on Line 21 of Form 1040. Calculate your income tax liability as you would otherwise to determine the amount of your settlement tax liability. Note that you are not eligible to use Form 1040-A or Form 1040-EZ if you owe taxes on forgiven debt.
  
  

Exemptions

• Section 108(a) of the Internal Revenue Code exempts taxpayers who are insolvent at the time the creditor extended the settlement. An insolvent taxpayer is one whose debts exceed his assets at the time he accepted the settlement(s). The IRC also exempts taxpayers whose debt settlement arose from bankruptcy proceedings. Exempt insolvent or bankrupt taxpayers are not required to disclose or pay taxes on debt settlements.