How Does Canceled or Forgiven Debt Affect Your Taxes?

What is debt forgiveness?

If you’re having difficulty paying off your debt, you may have options as far as debt forgiveness. These options could apply to you if you’re having trouble with: 

• Your mortgage
• Student loans
• Credit Card debt
• Medical bills

If your debt is outstanding and seemingly insurmountable, you may be able to request a lower payment or even a cancelation of that debt from your lender(s). These options may seem appealing in the short term but generally may increase your taxes.

Is debt forgiveness taxable?

Tax debt forgiveness affects every tax situation differently depending on a taxpayer’s individual or familial circumstances. For example, if you borrow money and your debt is forgiven by the lender, you generally need to include the canceled portion of the debt in your income. 

Lenders are also required to report the amount of debt canceled using Form 1099-C, Cancellation of Debt. However, there are several exceptions, like insolvency or bankruptcy, to reduce or eliminate the taxable portion of the canceled debt. 

Mortgage loan forgiveness, which happens when your home is foreclosed on, is not taxable on the 2020 return. However, the IRS doesn’t know if you qualified for the loan forgiveness without reporting on Form 982. 

To learn more about how debt cancelation might affect your taxes, check out IRS Publication 4681, Canceled Debts, Foreclosures, Repossession, and Abandonment.