How is cancellation of debt income taxed

To be insolvent means that you had more debts than assets. You must have been insolvent immediately before the debt was cancelled. You must fill out an IRS insolvency worksheet to prove your debts were greater than your assets. If these debts were discharged because you filed for bankruptcy , you were insolvent. You do not have to pay tax on the cancellation of debt.

The IRS will tack on interest expense, but fortunately, the interest rates for individuals are relatively low. Take Control of Your Finances Sign up to get the latest tax tips, information on personal finance and other key resources sent straight to your email.

The amount of canceled debt is included in your income unless an exception or exclusion applies. This concept is explained in detail in What should I do? I filed for bankruptcy. What happens to debt amounts then?

Read More. For Individuals Download. The Right to Be Informed. The Right to Retain Representation. Choosing a Tax Return Preparer. There are quite a few exceptions when it comes to the cancellation of debt income.

Defined by the IRS, the following are not considered cancellation of debt income:. The following exclusions are considered cancellation of debt income but the IRS excludes them from being reported as income. Negotiating the cancellation of debt with a creditor can be challenging.

Most creditors are not willing to cancel individual debts as interest and fees on approved credit is the main source of income influencing their bottom line. However, some creditors do include provisions in their credit agreements for canceled debt. Many creditors also have credit relief services which can be obtained for a small additional fee and used in specific hardship situations such as a job loss or a medical occurrence.

Reviewing the credit card terms of all creditors can help a borrower to identify on their own any creditors that they may easily qualify for debt cancellation from.

Certain loans issued under government programs may have a higher chance of debt forgiveness. These loans may include student loans or mortgage loans eligible for debt forgiveness under government-sponsored relief programs.

For distressed borrowers, some lenders may also be willing to negotiate principal reductions on mortgage loans since it could save them some of the costs of a foreclosure. Debt relief and settlement companies are available across the nation to help with debt forgiveness. Working with a credit counseling resource such as the National Foundation for Credit Counselors can help a borrower identify an appropriate program for their situation.

Debt settlement companies are for-profit entities that work on behalf of a borrower to negotiate a debt settlement with creditors. There are numerous caveats to working with these companies and the process for settlement can take years.

However, debt settlement can be an option for borrowers who have been steadily delinquent in payments. Debt relief programs will usually request that borrowers stop payments on their monthly credit bills in order to increase the likelihood that a creditor will settle. Generally, most companies will also require clients to make monthly escrow payments toward a lump sum settlement which would be paid at some time in the future. In many situations, bankruptcy may be the best option for a distressed borrower.

In bankruptcy, the borrower has the support of an attorney and the courts. Debt forgiveness is also not considered income in bankruptcy which can help save tax liabilities. Bankruptcy is a complicated process and the impacts can be long-standing. It's worth speaking to accountants and lawyers before heading down this path. IRS Topic No. Income Tax.