Negotiated Credit Card Debt & Tax Implications
- Forgiven or canceled debt is considered to be taxable income. For example, if a debtor negotiates to pay off a $5,000 credit card balance for $3,000, the $2,000 difference is considered to be taxable income. Certain exceptions and exclusions are discussed below.
- All canceled debt is to be added to the debtor's gross income on the appropriate year's tax return. The IRS requires that all canceled debts in the amount of $600 or higher be reported by the creditor on Form 1099-C. The amount of canceled debt reported usually includes any unpaid balance, including principal, interest and fees. In addition to the taxes due on that amount, the debtor's tax bracket could be pushed up, resulting in a higher tax rate.
- Any part of the canceled debt consisting of what would have been tax-deductible interest is not counted as taxable income. Credit card debt canceled due to bankruptcy is not counted as income. Debtors who demonstrate financial insolvency immediately before the canceling of a debt to exclude that amount from taxable income.
- The debtor has a right to ask for a corrected Form 1099-C if it is incorrect. The debtor must include canceled debt on his tax return whether or not he receives Form 1099-C. The debt is not considered canceled for tax purposes if the creditor charges it off. Debt amounts actively in collection, including from an entity that buys bad debt, are not considered canceled.