Tax Strategies & Credits

What You Need to Know About Cancellation of Debt Income

William Ray
What You Need to Know About Cancellation of Debt Income

When you have consumer debt forgiven, such as using a debt settlement agency to consolidate and forgive credit card debt or you had a home mortgage written off because it went underwater, you will receive a 1099-C tax form that says you have cancelation of debt (COD) income. Even though you likely had the debt forgiven because you were in poor shape financially, with no likelihood of being able to pay it off, COD income can often make a bad financial situation worse because you now owe federal and state income taxes on the forgiven debt. 

However, there are ways that you can avoid taxation on COD income. If your financial situation falls into any of the following categories, you may be able to exclude all or part of your forgiven debt in your taxable income.


If you filed for Chapter 11 bankruptcy and the court approves it, your canceled debt isn't likely to be taxed. However, the debtor must be in the same jurisdiction as the court that approved your bankruptcy proceeding. The debt forgiveness also must be granted by the same court. If the court doesn't expressly cancel your debt, then in order to be tax-free, your debt needs to be canceled as a result of your bankruptcy proceedings with approval from the court.

Student Loan Forgiveness

Student debt forgiveness may be a benefit of professional development programs for various fields, such as for healthcare professionals placed in underserved regions. Schools, charitable organizations, and all levels of government run these types of programs. 

Typically, forgiven student loans will not become taxable income in this situation unless you have private loans. Even if your loans were private, participation programs through universities or nonprofits meant to ameliorate labor shortages in underserved areas will ensure this canceled debt doesn't become taxable income. This even includes student loan refinancing from eligible lenders.

However, if you receive a student loan repayment as a benefit from a job then you must pay tax on the canceled debt. This is true even if the school is your employer.

Principal Residence Acquisition Debt Forgiveness Exclusion

Through 2016, a special provision allows taxpayer’s to exclude up to $2 Million of COD income from forgiven acquisition debt. Acquisition debt is debt used to buy, build, or substantially improve your primary residence.  You can incur COD income in a foreclosure, abandonment, short sale, and even when you negotiate a loan reduction with the lender.  Refinanced acquisition debt continues to be acquisition debt to the extent of the original amortized acquisition debt. 


You are insolvent when your debts exceed your assets.  If you are insolvent, you generally have a negative net worth. Tax law provides that to the extent an individual is insolvent his or her COD income is excluded from income. This applies both to the acquisition and equity debt.

When determining if you have negative net worth (you are insolvent) your net worth calculation needs to account for all personal debts such as student loans, credit cards, car notes, judgments, and other obligations. It also needs to account for all assets in addition to cash on hand, such as retirement funds, home equity, cash surrender value of life insurance, blue book value of vehicles, non-cash valuables like jewelry, belongings like books and clothing, and any other assets.

If your total debts exceed your total assets at the time the debt is canceled, you are insolvent and don't owe taxes on the canceled debt to the extent you are insolvent. For example, if your total debts were $50,000 and your assets were worth $35,000, you are insolvent to the extent of $15,000.  Thus only $15,000 of COD income can be is excluded from your income.

Understanding your options and planning are key elements to survive any financial crisis. Working with a professional advisor will take away the doubt that you are following the best course of action.

share this post
Search for matches...
William Ray

William Ray

William Ray is a specialist in IRS tax resolution problems. His firm, NationStar Tax Advisors, LLC is based in Orlando, FL, but services clients throughout the U.S. NationStar specializes in Wage Garnishment,Bank Levy, IRS Audit Notification, Payroll Tax Relief, and State Tax Problems.

Recommended Professionals

In the face of economic uncertainty, TaxBuzz is the industry's most up-to-date tax information.

Join 60,000 who get our weekly newsletter. No spam.

Need help selecting a firm?

Use our specialized search engine and get matched to the best accounting and tax firm for your needs.

Related Posts

Latest Posts