Uh Oh! That "Forgiven" Debt Might Still Haunt Your Taxes!
Imagine this: You're navigating the choppy waters of debt, feeling the pressure, when suddenly – poof! – a credit card company or lender decides to cut you a break. They forgive some of what you owe. You breathe a massive sigh of relief, right? "Freedom!" you think. Well, hold up a second, because the IRS might just be waiting in the wings to tap you on the shoulder.
It turns out, that debt you didn't have to pay back? The taxman often sees it as money you gained. They call it "phantom income" because you didn't actually get a paycheck, but your financial situation essentially improved because a liability vanished. It's like finding a treasure chest, except the treasure was actually a debt that disappeared. Confusing, I know!
If a lender forgives $600 or more of your debt (and yes, this applies to credit cards too!), they're likely going to send you (and the IRS) a little form called a 1099-C, or "Cancellation of Debt." This form is their way of saying, "Hey IRS, this person got a financial break!" And guess what? The IRS usually says, "Great! That's income, and income gets taxed."
Why does this happen? Think of it this way: when you borrowed money, it wasn't income. But when you don't have to pay it back, it's essentially a benefit you received that you didn't earn or pay for. The government views it similarly to earning money.
Luckily, there are a few exceptions. If you go through bankruptcy, or if you're officially "insolvent" (meaning your debts were bigger than your assets before the debt was canceled), you might be off the hook. But these are specific situations, and you'll usually need some paperwork and possibly professional advice to prove it.
So, what's the big lesson here? Don't ignore those forms that show up in the mail, especially if they look official and mention "Cancellation of Debt." A canceled debt can feel like a huge win, but it's crucial to understand the potential tax implications. A little heads-up now can save you a big headache (and tax bill!) later. When in doubt, always chat with a tax pro!
Original article inspiration: https://www.marca.com/en/lifestyle/us-news/personal-finance/2025/12/06/69345645268e3e53128b45a4.html