Debts "Written Off" May Count as Taxable Income

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Many people do not know that having a debt "written off" or forgiven may count as taxable income. When income is taxable, it must be reported to the IRS. Most of the time, money you borrow to buy a car, home or other personal items does not count as income because you have to pay it back. If you are unable to pay it back and the company writes it off, it can count as taxable income. This income is called "cancellation of indebtedness income."

What determines whether or not a forgiven debt counts as taxable income?
It may depend on your financial situation at the time the debt is forgiven. If a taxpayer is insolvent, all or part of the debt forgiven may not be taxable.

When is a taxpayer "insolvent?
A taxpayer is insolvent if his or her total assets are worth less than the amount owed for debts. Here are two different cases where debt forgiveness might happen.

Case 1: A Credit Card is Cancelled
Ted owes $5,000 to a credit card company. The company sues him. Ted responds and asks the court to award damages for unfair debt collection practices. The credit card company agrees to dismiss the suit. The company agrees not to try to collect anymore if Ted dismisses his claim, too. Both parties dismiss their claims "with prejudice." This means neither Ted nor the credit card company can try to sue over this issue again.

The credit card company sends IRS Form 1099-C to Ted on January 30, 2018. The 1099-C lists the debt forgiven as $5,000 on the date of September 12, 2015. The box is checked that Ted was personally responsible for the debt. Because this was a credit card debt, the credit card company did not get any property back, so the rest of the form has zeroes. Ted may have $5,000 of cancellation of debt income.

Ted needs to look at his financial situation right before the date of the cancellation to see if he meets an exception that could allow him to avoid having to report this as income.

Ted's Finances Right Before 9/12/15

Assets Owned

Debts Owed

Car.....................$1,000 Car loan.............$1,500
Items .................$1,000
Card A .............. $5,000
Checking ..........$ 100  
Total assets .......$2,100 Total debts ........$6,500

Ted owes more than he owns in assets. Ted is insolvent by $6,500-$2,100 or $ 4,400. Ted had $5,000 forgiven. Ted will only claim $600 in cancellation of debt income. This is the amount the debt forgiven was more than his insolvency. $5,000-$4,400=$600.

Case 2: A Car is Repossessed and the Loan is Cancelled
When a house is foreclosed or an auto repossessed, there are two potential types of income: Cancellation of indebtedness income and Gain or a Loss from the sale of an item.

Allison bought a car for $10,000. She owed $7,700 when it was taken back by the bank on July 23, 2017. The bank decided she could not pay them and forgave the remaining debt after selling the car. The potential cancellation of indebtedness income is $7,700 (total amount owed)- $5,800 (Fair Market Value) or $1,900.

Allison's Finances Right Before 7/23/17

Assets Owned Debts Owed
Toyota FMV .....$5,800 Car Loan........... $7,700
Items .................$1,000
Card A .............. $5,000
Checking ..........$ 200  
Total assets .......$7,000 Total debts ......$12,700

Allison owes more than the value of her assets. She is insolvent by $5,700. Since the debt forgiven ($1,900) is less than how much she is insolvent ($5,700), none of the forgiven loan counts as taxable income. Allison will file a form 982 to explain that the amount reported on Form 1099-C was not taxable because she was insolvent.

Other Cases where forgiven debt does not count as income
A debt discharged through bankruptcy should not be taxed as income. Also, loans on primary residences forgiven between 2007 and December 2019 may not count as income to the taxpayer. To find out more about forgiveness of mortgage loans, see "I Lost My House Now I Owe Taxes?" at To get to the article, select "Get Legal Information," then choose the topic "Taxes." Click on "Tax Troubles" then scroll down.

I didn't get a 1099-C from the lender but just got a notice from the IRS. Now what?
You may not get a 1099-C in the mail from a lender when it's time to work on your taxes. Maybe they didn't write off the debt right away. The lender may not have your current address because you moved. The first time you hear about this form could be from the IRS. If you get a notice from the IRS saying you didn't report all your income, don't panic. You may be able to get help with this type of problem.

Where Can I Get Help for a Tax Problem or have a question about this article?
If you have tax problems, you may be able to get help from Iowa Legal Aid's Low-Income Taxpayer Clinic. Call Iowa Legal Aid at 1-800-532-1275 for details.

  • Iowa Legal Aid provides help to low-income Iowans. 
    • To apply for help from Iowa Legal Aid:call 800-532-1275. 
    • Iowans age 60 and over, call 800-992-8161 or 
    • apply online at
If Iowa Legal Aid cannot help, look for an attorney on “Find A Lawyer” on the Iowa State Bar Association website   A private attorney there can talk with you for a fee of $25 for 30 minutes of legal advice.
*As you read this information, remember this article is not a substitute for legal advice. 
Last Review and Update: Sep 28, 2020
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