What Are the Tax Implications of Settling Debt?

How Debt Settlement Works

Debt settlement is the process of getting creditors to accept less in payment than what you owe. Although creditors would prefer to be repaid in full, they may be willing to settle if it means they can avoid sending your debt to collections or help you steer clear of bankruptcy.

You may be able to negotiate a debt settlement on your own, but you can also work with a debt settlement company that will negotiate with creditors on your behalf. Debt settlement is risky, however: Debt relief companies often use tactics that damage your credit. In addition to the fees you'll have to pay the debt settlement company for negotiating and administering your account, any reduction in the amount you owe your creditors is likely to be considered income by the IRS.

Learn more: Debt Settlement vs. Debt Management Programs

What Are the Tax Implications of Debt Settlement?

With a few exceptions, the IRS considers canceled credit card debt to be taxable. Depending on the laws in your state, you may also owe state income tax on settled debt; check with your state taxing authority for more information. Here's what to know about the tax implications of settling your credit card debt.

Forgiven Debt Is Taxable Income

The IRS taxes canceled or forgiven debt as regular income, the same as your wages or interest earned on your bank account. Although there are exceptions and exclusions, in general any credit card debt your creditor forgives is taxable.

Example: If you settle $5,000 in credit card debt for $1,500, the IRS will expect you to report the $3,500 in debt forgiveness on your tax return and pay regular income taxes on it.

Settled Debt Is Reported on Form 1099-C

If a creditor forgives $600 or more in debt, they'll issue a Form 1099-C showing the amount of debt they canceled. Here's what to do if you receive a 1099-C.

• Check your records. Compare the amount of forgiven debt shown on the 1099-C to your records. Contact the lender or creditor if you find a discrepancy, or if you were not aware that the debt was forgiven.
• Add the income to your tax return. Report the canceled debt shown on the 1099-C on your tax return.
• Request a missing 1099-C. If you had $600 or more in canceled debt and you don't receive a 1099-C, contact the creditor. You can report the income without the form, but ideally your reported debt should match what's shown on any 1099-C that's been issued, since the form is submitted to the IRS.
• Report canceled debt, with or without a 1099-C. If you have canceled debt that was not reported on a 1099-C, you should still report it and pay tax on it (if tax is required). Even small debts of less than $600 are considered taxable.

Bankruptcy Debts Are Excluded

If your credit card debt has been discharged in bankruptcy, the discharged debt may be excluded from federal income tax. You may still need to report the discharged debt on your tax return, but you typically don't need to pay tax on it.

Insolvency Can Exclude Some or All of the Income

Settled debt also may be excluded if you were insolvent just before the debt was forgiven. Insolvency means owing more than the fair market value of all your assets.You can use the insolvency worksheet in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments to help determine whether (and to what extent) you were insolvent.

Note: Your excluded debt can't be greater than the amount of your insolvency. If you owe $50,000 and have $40,000 in assets, you can exclude up to $10,000 in forgiven debt. Beyond that, your settled debt is considered taxable.

How Much Is Settled Debt Taxed?

Settled debt is taxed at your top marginal tax rate, between 10% and 37%, depending on your taxable income. Like earned income, bank interest or short-term capital gains, settled debt is taxed progressively according to your tax bracket.

Example: You're a single taxpayer with annual income of $85,000. Using 2026 tax brackets, the top marginal tax rate for a single person earning up to $105,700 is 22%. Any settled debt you have up to $20,700 (or $105,700 minus $85,000) will be taxed at 22%. Settled debt beyond $20,700 will be taxed at higher marginal tax rates: 24%, 32%, 35% or 37%.

How Do I Know if I Owe Taxes From Debt Settlement?

If you settled debt during the past year, be prepared to do a little legwork to figure out your tax liability. You can do a quick estimate if you know how much debt forgiveness you received and your most recent (or current) top marginal tax rate. For a more accurate accounting, follow the steps below.

1. Add up your settled debt. Use your own records and any 1099-C forms you've received to total up your canceled debt for the year.
2. Apply exceptions and exclusions. Check instructions for Form 982 to see if your settled debt qualifies for a reduction in tax attributes.
3. Complete your tax return. Report your canceled debt using Schedule 1: Adjustments to Income and Additional Income. Enter the total amount of canceled debt for the tax year on line 8c, then report your total Schedule 1 income on line 8 ("other income") of your federal tax return, Form 1040. Your canceled debt is added to your wages, interest earnings and other taxable income.

Exceptions to Canceled Debt

Your settled debt may not be taxable if any of the following IRS exceptions apply:

• Your debt was canceled as a gift, bequest or inheritance.
• Your student loan forgiveness is eligible for an exclusion, including debt discharged between 2021 and 2025 under the American Rescue Plan Act; loans forgiven as part of Public Servant Loan Forgiveness, Teacher Loan Forgiveness or another employment-related program; or loans canceled due to the death or total and permanent disability of the student.
• Interest on your canceled debt would have been deductible if you had paid it. Example: deductible mortgage interest.
• Your loan balance was reduced when the seller lowered the qualified purchase price, for instance by discounting the sale price of a home

Excludable Debts

The following settled debts may be excluded from your taxable income, even though the IRS considers them canceled debts:

• Debts discharged in bankruptcy
• Debt canceled when you are insolvent (your debts outweigh your assets)
• Qualified farm indebtedness
• Qualified real property business indebtedness
• Qualified principal residence indebtedness discharged before January 1, 2026

If you need help sorting this information out, try using tax preparation software. Alternatively, you may want to meet with a tax professional who can help you do the calculations and start planning for any additional taxes. If you can't afford to pay your tax bill, you may be able to apply for tax debt relief or arrange a payment plan with the IRS.

The Bottom Line

Because taxes are likely to be a factor, consider your tax bill early in the debt settlement process, preferably before you sign an agreement. Seeking out a debt settlement arrangement is often a sign that finances are tight. If meeting your debt obligations is difficult, paying taxes on settled debt might be too. Make sure your taxes will be covered in any debt settlement arrangement you work out.

If you've recently settled debt, you may also want to check on your credit. Debt settlement can affect your credit, and often for the worse. Checking your FICO^® Score^Θ for free with Experian can help you note the effects on your credit and consider ways to rebuild your credit over time.