Debt Settlement Taxes: Understanding the Tax Implications of Forgiven Debt [Updated for 2025]
- When debt is settled, the amount forgiven is generally taxable.
- There are exceptions for certain types of debt or in cases of bankruptcy or insolvency.
- Find out if the debt will be taxed before you pursue debt forgiveness.
Table of Contents
- How Debt Settlement Taxes Work
- Legal Exceptions to Paying Taxes on Settled Debt
- Timing Strategies for Debt Settlement
- The Impact of Debt Settlement on Your Tax Return
- Debt Settlement vs. Other Debt Relief Options: Tax Comparison
- Professional Guidance: Seek Tax Advice
- How Freedom Debt Relief Helps People Like You Get Rid of Debt
Debt settlement can take a huge weight off your shoulders. No more worrying about overdue accounts or calls from collection agencies. You settle your debt for an amount you can afford, or you have a professional debt settlement company handle negotiations for you. Once you’ve paid the agreed-upon amount, you can move on with your life.
After the initial relief, though, you may face one more bill to pay: taxes on your debt settlement. The Internal Revenue Service (IRS) usually considers forgiven debt to be taxable income. That could mean a higher tax bill than expected when you file your return.
Before you pursue debt settlement, learn about the possible tax consequences. This way, you’ll know how settling debt could affect your finances and you can make sure it’s the right move for your situation.
We’ll cover the ins and outs of debt settlement taxes, some legal exceptions that could help you avoid these taxes, tax implications of other debt relief options, and when to seek professional advice. Many people could qualify for an exception to debt settlement taxes. Even if you don’t, you can still minimize how much tax you have to pay on settled debt.
Every situation is different, and we’re not tax advisors. This information is general but some of it might not apply to you. Please contact a tax professional to discuss potential tax consequences of less than full balance debt relief.
How Debt Settlement Taxes Work
In debt settlement, the creditor agrees to accept a smaller amount than what you owe. The rest of your debt is forgiven. For tax purposes, canceled debt is taxable income unless you qualify for tax-free debt forgiveness.
The basics of debt settlement taxation
Debt settlement taxes are income taxes owed on the amount of debt that a creditor agrees to forgive. To calculate the amount of debt being forgiven, subtract the debt settlement amount from the total amount you owe. Here’s an example:
Total debt | $15,000 |
---|---|
Debt settlement amount | $8,000 |
Forgiven debt | $7,000 |
Amount added to your taxable income | $7,000 |
When a creditor forgives your debt, it’s as if they gave you money to pay toward your debt. For this reason, the IRS considers the amount forgiven to be income. You must declare the forgiven debt on your tax return, and you could owe taxes on that amount, just as you would on any other income.
Calculating your potential tax liability
Here’s a simple, step-by-step process to estimate how much you might owe in debt settlement taxes:
Find your marginal tax rate. Your marginal tax rate is the highest tax rate on your income—but it doesn’t apply to every dollar you earn.
Calculate the amount of debt being forgiven. You just need to subtract the debt settlement from the total amount you owe.
Multiply the amount of forgiven debt by your marginal tax rate. The result is your potential debt settlement taxes. The IRS website has federal income tax rates and brackets you can use to find the tax rate for your income.
Let’s say a creditor has agreed to forgive $7,000 of debt, and this amount doesn’t change your marginal tax rate. Here’s how the math works.
Step 1) Amount of debt forgiven: $7,000
Step 2) Salary: $35,000 per year after deductions
Step 3) Your marginal tax rate that year as a single filer: 12%
Step 4) How to calculate your tax liability on that portion
7,000 x .12 = 840
Things are a bit more complicated if the amount of your forgiven debt pushes you into a higher tax bracket. In this case, you’d need to calculate how much of your debt falls into that higher rate.
For example, you earned $45,000 in 2024 and had $5,000 in forgiven debt. Your taxable income puts you in the 12% tax bracket, but your canceled debt could fall into two tax brackets. Here’s how you might calculate your tax liability:
Step 1) The first $2,150 of forgiven debt stays in the 12% tax bracket
Step 2) The remaining $2,850 of forgiven debt pushes you into the 22% tax bracket—and that's the only part of your income taxed at 22%
Step 3) How to calculate your tax liability on these two amounts:
2,150 x .12 = 258
2,850 x .22 = 627
258 + 627 = 885
In this scenario, your total debt settlement taxes would be $885.
The table below shows the amount of federal taxes you might pay on $15,000 in forgiven debt at different marginal tax rates.
Marginal Tax Rate | Debt Settlement Taxes on $15,000 |
---|---|
10% | $1,500 |
12% | $1,800 |
22% | $3,300 |
24% | $3,600 |
32% | $4,800 |
35% | $5,250 |
37% | $5,550 |
Form 1099-C and IRS reporting requirements
After you’ve settled debt, you may receive Form 1099-C by Jan. 31 of the next tax year. This form reports how much debt was canceled. Creditors and collection agencies must use the form to tell the IRS when they cancel $600 or more of debt.
You include the amount given on the Form 1099-C with your taxable income when you file your taxes. The deadline to report canceled debt is the same deadline for the year you settled your debt. In other words, if you had debt forgiven in 2025, you’ll include that information when you file taxes in 2026.
You might not receive a tax form if you had less than $600 of canceled debt. Even if you don’t receive a 1099-C, you still need to report canceled debt with your taxable income. Any amount of canceled debt is taxable income and should be reported on your taxes.
Keep a record of your debt settlement, including the amount of forgiven debt. That record lets you accurately report the canceled debt on your taxes. If you get a 1099-C, you can also confirm that the amount of canceled debt on the form is correct. If you believe the amount is wrong, contact the creditor that issued the form.
Legal Exceptions to Paying Taxes on Settled Debt
Settled debt may not always mean a tax bill because of several exemptions. Depending on the type of debt and your financial situation, you might not have to pay taxes on a debt settlement.
Bankruptcy exclusion
Debt that was canceled as part of bankruptcy can be left off your taxable income. People who complete bankruptcy, whether Chapter 7, Chapter 11, or Chapter 13, are already required to pay as much as they can to their creditors. The IRS doesn’t tack on additional costs in the form of taxes.
Hang on to your bankruptcy documents, and make a note of how the total amount of debt canceled. You can claim the bankruptcy exclusion using Form 982.
Bankruptcy could help you get rid of debt without any additional tax liability.
Insolvency exclusion: A detailed guide
The IRS considers you insolvent if the total value of your debt is more than the total value of what you own. If you’re insolvent when you settle a debt, you don’t owe taxes on the forgiven amount. But insolvency is a sliding scale.
You can leave canceled debt off your income, up to the amount you were insolvent when the debt was canceled.
For example, if you have $300,000 in assets and $350,000 in debts, then you’re $50,000 insolvent. You could exclude up to $50,000 in canceled debt from your taxable income.
To calculate insolvency, add up the value of the things you own, and the total of your debts. Here are some examples of assets:
Cash and bank account balances
Homes
Cars
Household goods
Electronics
Stocks and bonds
Clothing
Collectibles
Here are some common examples of liabilities or debts:
Mortgage
Auto loans
Student loans
Medical bills
The IRS includes an insolvency worksheet in Publication 4681, which covers taxes on canceled debts, exceptions, and exclusions. This worksheet helps you calculate your total insolvency. Use asset and liability numbers from just before your debt settlement.
Documenting your assets and debts is a good way to prove insolvency. For your debts, you could request and download billing statements from before you settled your debt. For assets, do your best to get proof of the fair market value of what you own. That could be a printout from a real estate website showing your home’s estimated value or a Kelly Blue Book listing for your car.
Here’s an example of an insolvency calculation.
Asset | Fair Market Value | Liability | Amount |
---|---|---|---|
Home | $400,000 | Mortgage | $380,000 |
Car | $30,000 | Auto loan | $35,000 |
Bank accounts | $2,000 | Student loans | $60,000 |
Electronics | $3,000 | Credit card debt | $20,000 |
Household goods | $5,000 | Medical bills | $5,000 |
Total Assets | $440,000 | Total Liabilities | $500,000 |
When you subtract $500,000 in liabilities from $440,000 in assets, this person would be $60,000 insolvent. If they had $30,000 in debt forgiven, they could likely use the insolvency exclusion to avoid paying debt settlement taxes.
Other IRS exceptions and exclusions
The IRS also has exemptions for canceled student loans, mortgage debt, and farm and business property.
Student loan forgiveness is normally taxable, unless the loans were canceled:
Through Public Service Loan Forgiveness
During the American Rescue Plan Act (lifted federal taxes on student loan forgiveness for loan cancellations 2021 through 2025)
By student loan repayment assistance programs
Some homeowners may be eligible for the qualified principal residence indebtedness exclusion. If you took out a mortgage to buy, build, or substantially improve your main home, you could use this tax provision if any of your eligible mortgage debt was discharged.
There are also exclusions for qualified farm indebtedness and qualified real property business indebtedness. If you believe any of these could apply to your situation, consult with a tax professional.
Timing Strategies for Debt Settlement
Even if you’ll need to pay debt settlement taxes, you may be able to time your settlement in a way that reduces the impact. The tax year of your debt settlement is the main consideration.
Tax year considerations
Debt settlement officially counts toward your taxable income on the date the creditor forgives your debt. After that, you have until next year’s tax filing deadline to pay your debt settlement taxes.
For example, your debt settlement is Dec. 15, 2025. The forgiven debt is part of your taxable income for 2025. You would need to pay the required taxes by April 15, 2026—the filing deadline for the 2025 tax year.
If you delay your debt settlement by just a couple of weeks to January, you get another year before the taxes are due. The forgiven debt would be part of your taxable income for 2026. You’d have until April 15, 2027, the filing deadline for the 2026 tax year, to pay the required taxes. When the end of the year is getting close, holding off on a debt settlement could give you much more time to pay your taxes. A few situations when it could make sense to push settlement to the following year are when you:
Don’t have money saved to cover the tax burden of settled debt
Are planning to use your tax refund to improve your financial situation
Expect to earn less in the next year and have a lower tax rate
Whether or not you push back your debt settlement, get ready to pay your taxes when they’re due. Otherwise, you could end up facing interest and penalties.
Estimate how much you’ll owe in debt settlement taxes. Then, figure out what tax filing deadline using the date of your settlement. With that information, you can calculate how much you need to save each month so you’re able to pay your tax bill.
Combining with other tax strategies
You can time your debt settlement to take control of your taxes. The best person to help you navigate this situation and optimize your taxes is a tax professional.
The Impact of Debt Settlement on Your Tax Return
You most likely will need to include canceled debt on your tax return. Taxes apply to both the amount you borrowed plus any interest or fees that accrued on the debt. Basically, whatever amount the creditor agrees to cancel is considered taxable income.
Required tax forms and documentation
You generally report any income, such as wages and canceled debt, on Form 1040 when you file your taxes. If the creditor canceled at least $600 in debt, then it will likely send you Form 1099-C, which shows the amount of your canceled debt. You need to report any canceled debt on your tax return even if you don’t get a 1099-C form.
If you want to exclude canceled debt from your taxable income, you can file Form 982. This form lets you report exclusions for debt settlement taxes if you filed bankruptcy or can prove insolvency. Other exclusions include some types of student loan forgiveness, mortgage debt, or farm or business debt.
Detailed record keeping is a big help when tax time rolls around. Here are a few tips to make it easier to create your tax return:
Save a copy of your debt settlement agreement. This should show the total amount you owed and the settlement amount.
If the amount of forgiven debt in a 1099-C doesn’t match your records, contact the creditor that issued the tax form.
Save billing statements for all your debts immediately before your debt settlement. You’ll need these records if you plan to use the insolvency exclusion.
Save records or estimates of the fair market values of your assets immediately before your debt settlement. You’ll also need these records for the insolvency exclusion.
State tax considerations
Your tax burden on canceled debt depends on the state where you live. Nine states have no state income taxes on wages as of 2025. If you live in one of these states, then you don’t owe your state any debt settlement taxes:
Alaska
Florida
Nevada
New Hampshire
South Dakota
Tennessee
Texas
Washington
Wyoming
In states that charge income taxes, rules vary on canceled debt. Many states follow the IRS and tax canceled debt as income. High-tax states that do this include California and New York.
There are exceptions, though. For example, New Jersey exempts canceled debt from taxable income.
Since state tax laws vary, check the rules for your state. For state-specific guidance, visit the website for the state’s department of taxation.
Debt Settlement vs. Other Debt Relief Options: Tax Comparison
Debt settlement is one type of debt relief. Other options include debt consolidation, bankruptcy, and debt management plans. Here’s how taxes work for each of these options compared with debt settlement.
Debt consolidation tax implications
Debt consolidation doesn’t add to your tax burden. When you consolidate debt, you’re simply using one new loan or line of credit to pay off multiple debts. You still pay your debt in full. Since you’re not having any debt forgiven, there are no debt consolidation taxes.
Debt consolidation has a tax advantage if you don’t qualify for any exceptions to debt settlement taxes. It’s not going to raise your tax bill. You may want to consider debt consolidation if:
You’re solvent, meaning your assets are worth more than your debt. In this case, you wouldn’t qualify for the insolvency exclusion to debt settlement taxes.
You can qualify for a debt consolidation loan or line of credit.
You’ll be able to afford the monthly payment after you consolidate your debt.
Debt management plans and tax considerations
A debt management plan (DMP) is a payment plan set up by a nonprofit credit counseling organization. If you work with a credit counselor, they may enroll you in a DMP if they think it fits your situation. The credit counselor would then negotiate a payment plan with your lenders.
DMPs don’t involve debt forgiveness. You pay off your entire debt over the course of the plan. No canceled debt means no taxes related to the debt forgiveness.
A DMP can be advantageous from a tax perspective, but it’s not always the better choice.
Take two people who both have $10,000 in debt.
John decides to work with a credit counselor and enrolls in a DMP. He completes the plan in five years, paying the entire $10,000 debt. Since he paid in full, he doesn’t owe any additional taxes.
Amy decides to work with a debt relief company. A settlement agreement is worked out, and she’ll pay $5,000. It takes her three years to complete the agreement. On top of the settled debt amount, she pays a 25% fee to the debt relief company on the total amount of debt. She also pays a tax rate of 12% on the amount of settled debt when she files her taxes. Even with the taxes and the debt settlement fee, she pays less overall and gets rid of debt two years sooner.
Settled debt | $5,000 |
---|---|
25% fee | $2,500 |
Tax bill (12%) | $600 |
Grand total | $8,100 |
Professional Guidance: Seek Tax Advice
Taxes are so important you want to get them right. So, talk to a tax professional.
It’s a great idea to get professional guidance if you:
Are considering debt settlement but you’re not sure about the tax consequences
Want to know if you qualify for any legal exceptions to debt settlement taxes
Aren’t sure if you’re considered insolvent by IRS standards
Need help preparing your tax return, especially if you’re applying for an exception or exclusion on your taxes
There are several types of tax professionals. Enrolled agents (EAs) are IRS-authorized tax practitioners. Certified public accountants (CPAs) are qualified to offer a range of tax and financial services, including tax planning, bookkeeping, and financial planning. Tax attorneys specialize in tax law. All three professionals can provide tax advice and represent clients before the IRS.
For debt settlement taxes, a CPA or EA would be an appropriate option. Either could prepare your taxes, though EAs tend to be less expensive. Both can give tax advice.
How Freedom Debt Relief Helps People Like You Get Rid of Debt
If you’re struggling with debt, Freedom Debt Relief can help. Over more than 20 years in business, we’ve served more than 1 million clients and resolved over $20 billion in debt.
Here’s how Freedom Debt Relief works: Our process starts with a free debt evaluation. A Certified Debt Consultant will talk to you about your debt, income, and expenses to come up with a debt relief plan. Then, instead of making payments to several creditors every month, you’ll just make one monthly deposit in a debt settlement account.
Our trained experts will negotiate debt settlement offers with your creditors on your behalf. You’ll receive notifications of each offer and decide whether to accept. Once you’ve approved a settlement, the payment is made from your debt settlement account.
Ready to get free of debt and build a better financial future? Get your free debt evaluation online or call 800-910-0065 to speak to a Certified Debt Consultant.
Debt relief by the numbers
We looked at a sample of data from Freedom Debt Relief of people seeking credit card debt relief during July 2025. This data reveals the diversity of individuals seeking help and provides insights into some of their key characteristics.
Debt relief seekers: A quick look at credit cards and FICO scores
Credit card usage varies significantly across different age groups, reflecting diverse financial needs and habits.
In July 2025, the average FICO score for people seeking debt relief programs was 594.
Here's a snapshot by age group among debt relief seekers:
Age group | Average FICO 9 credit score | Average Credit Utilization |
---|---|---|
18-25 | 575 | 82% |
26-35 | 584 | 79% |
35-50 | 588 | 77% |
51-65 | 596 | 74% |
Over 65 | 608 | 69% |
All | 594 | 75% |
Use this data to evaluate your own credit habits, set financial goals, and ensure a balanced approach to managing credit throughout your life.
Personal loan balances – average debt by selected states
Personal loans are one type of installment loans. Generally you borrow at a fixed rate with a fixed monthly payment.
In July 2025, 44% of the debt relief seekers had a personal loan. The average personal loan was $10,718, and the average monthly payment was $362.
Here's a quick look at the top five states by average personal loan balance.
State | % with personal loan | Avg personal loan balance | Average personal loan original amount | Avg personal loan monthly payment |
---|---|---|---|---|
Massachusetts | 42% | $14,653 | $21,431 | $474 |
Connecticut | 44% | $13,546 | $21,163 | $475 |
New York | 37% | $13,499 | $20,464 | $447 |
New Hampshire | 49% | $13,206 | $18,625 | $410 |
Minnesota | 44% | $12,944 | $18,836 | $470 |
Personal loans are an important financial tool. You can use them for debt consolidation. You can also use them to make large purchases, do home improvements, or for other purposes.
Tackle Financial Challenges
Don’t let debt overwhelm you. Learn more about debt relief options. They can help you tackle your financial challenges. This is true whether you have high credit card balances or many tradelines. Start your path to recovery with the first step.
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Author Information

Written by
Lyle Daly
Lyle is a financial writer for Freedom Debt Relief. He also covers investing research and analysis for The Motley Fool and has contributed to Evergreen Wealth and Monarch Money.

Reviewed by
Kimberly Rotter
Kimberly Rotter is a financial counselor and consumer credit expert who helps people with average or low incomes discover how to create wealth and opportunities. She’s a veteran writer and editor who has spent more than 30 years creating thousands of hours of educational content in every possible format.
Do I have to pay taxes on settled credit card debt?
Yes, you have to pay taxes on settled credit card debt, unless you qualify for an exclusion. One of the most common exclusions is insolvency. If you’re insolvent, meaning your debts are higher than your assets, then you could leave canceled debt off your income.
How much tax will I pay on forgiven debt?
The taxes you pay on forgiven debt depend on your tax bracket. Forgiven debt is generally considered taxable income, so you add it to your income on your tax return.
It’s possible to pay zero income taxes on canceled debt if you were insolvent when the debt was forgiven. Insolvent means the amount of your debts is greater than the value of what you own.
Can the IRS see my debt settlement?
The IRS doesn’t see your debt settlement. If the creditor files Form 1099-C, the IRS gets a copy of that. Financial companies are required to file a 1099-C after they forgive $600 or more in debt. Any amount of canceled debt is still taxable income and should be included on your tax return—even if you don’t receive the form from the creditor.
What is Form 982 and how do I fill it out?
Form 982 is a tax form you can file to exclude canceled debt from your taxable income. The form and instructions for filling it out are on the IRS website. If you need assistance with the form, contact a tax professional.
Will debt settlement affect my tax refund?
A debt settlement could reduce the amount of your tax refund. You generally need to add discharged debt to your taxable income, which increases your taxes.
Is insolvency hard to prove to the IRS?
You can claim insolvency to the IRS by filling out an insolvency worksheet. This usually isn’t too difficult, especially if you’ve kept accurate records of your debts and assets. If you need help, you could work with a tax preparer.
How long do I have to report canceled debt on my taxes?
You have until the next year’s tax filing deadline to report canceled debt on your taxes. For example, debt canceled in 2025 needs to be reported on your 2025 tax return, which is due April 15, 2026.
Do I need to pay estimated taxes on debt settlement?
You may need to pay estimated taxes on a debt settlement to avoid an underpayment penalty. This depends on the amount of canceled debt and what you expect to owe in taxes. Consider working with a tax professional to get advice for your specific situation.
Can I deduct debt settlement fees on my tax return?
No, you typically can’t deduct debt settlement fees on your tax return. Debt settlement fees are a personal expense, which isn’t tax-deductible.
How do I know if I'm insolvent for tax purposes?
To find out if you’re insolvent, add up the value of all your assets and your debts. If you have more in debt than in assets, you’re insolvent for tax purposes. The IRS has an insolvency worksheet you can use to calculate this.
Can I negotiate with the IRS on debt settlement taxes?
No, you can’t negotiate with the IRS on debt settlement taxes, but you have other options. If you want to avoid debt settlement taxes, you could find out if you qualify for an exclusion, such as insolvency. If you can’t pay your full tax bill, you could make an offer in compromise and try to settle your taxes for a lower amount.
What happens if I don't report canceled debt on my taxes?
If you don’t report canceled debt on your taxes, the IRS could charge you penalties and interest on the amount you owe.
Are debt settlement taxes different for business debts?
Debt settlement taxes work the same way for personal and business debt. However, the tax filing process is different for businesses, which also pay different tax rates.
How does debt settlement affect my future tax situations?
Debt settlement could increase your tax liability for the tax year when you settle your debt. You would need to pay taxes on the forgiven debt, unless you qualify for an exclusion.
Can Freedom Debt Relief help with the tax implications of settlement?
Freedom Debt Relief doesn’t offer tax planning services or advice.

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