Cancellation of Debt and Form 1099-C

When a lender cancels or forgives a debt, the amount you no longer owe is generally treated as income, even though you did not receive any cash. The lender reports it to you and the IRS on Form 1099-C. Receiving that form can be alarming, but you may be able to exclude some or all of the amount. This guide explains the rules, the exclusions and what to do if the form is wrong.

How canceled debt becomes income

If you owe a debt and the lender accepts less than the full amount, or the lender gives up on collecting, the unpaid amount is canceled debt. For example, if you owed $1,000 and paid $400 in full settlement, you have $600 of canceled debt. Common situations are credit card settlements, personal loans, a short sale, foreclosure, car repossession with a leftover balance, or a loan modification that reduces principal.

The creditor reports the canceled amount in box 2 of Form 1099-C, with an event code in box 6. The IRS instructions list identifiable events such as a bankruptcy discharge, an agreement to cancel for less than full payment, a short sale, or a decision or policy of the creditor to stop collecting. A creditor's defined practice of dropping debts after a particular nonpayment period can also count. You report the amount on Schedule 1, line 8c, unless an exclusion applies.

Not every canceled amount is income. Gifts and inheritances are not. Debt that would have been deductible if you had paid it, and a price reduction after you buy something, are not canceled-debt income. Some student loan discharges are also excluded, as described below.

Exclusions

The insolvency exclusion

Assets for this test include everything you own, including retirement accounts and assets that are protected from creditors, along with assets that serve as collateral. Liabilities include recourse debts and certain nonrecourse debts. The exclusion cannot be more than the amount by which you were insolvent. The IRS offers an insolvency worksheet in Publication 4681.

Example: Priya has a credit card with a $12,000 balance. In 2025 she settles with the card company for $4,000 and receives a Form 1099-C for $8,000. Just before the settlement, her debts total $38,000 and her assets are worth $30,000, so she was insolvent by $8,000. She can exclude all $8,000 by filing Form 982. If her debts had been only $33,000, she would have been insolvent by only $3,000, and $5,000 would stay in income.

Form 982 and tax attributes

When you exclude canceled debt, you generally must reduce certain "tax attributes," such as net operating losses, credit carryovers, capital loss carryovers and the basis of property. The reduction happens after your tax for the year is figured. The exclusion defers some tax benefits rather than erasing them. Attach Form 982 to your return to claim an exclusion.

Home and student loan changes

Mortgage debt. The qualified principal residence exclusion cannot be used for discharges completed, or discharge agreements entered into, after December 31, 2025. A written arrangement made before 2026 can still qualify for a later discharge. Foreclosures and short sales can also create a gain or loss on the home sale, which may be excluded under the rules in our home sale exclusion guide.

Student loans. The IRS lists several kinds of student loan relief that can be tax free: cancellation for meeting certain work requirements, certain loan repayment assistance programs, and cancellation because of the student's death or total and permanent disability. The broader exclusion for other student loan discharges applied only from 2021 through 2025. For discharges after 2025, the death or disability exclusion requires a Social Security number that is valid for employment and was issued before the return's due date. Other forgiveness after 2025 can be taxable, so check which type of discharge you received.

If the Form 1099-C looks wrong

• Wrong amount or not your debt: Contact the creditor and request a corrected form. You are still responsible for reporting the correct taxable amount.
• Debt still being collected: If the creditor keeps collecting, the debt may not have been canceled, and you can raise that with the creditor.
• Ignoring it: The IRS matches the form to your return. If the income is missing, it may send a notice. See CP2000 notice.
• Old debts: The IRS instructions for Form 1099-C say the expiration of a collection time limit is an identifiable event only when a court has upheld the debtor's defense in a final judgment. Get advice before assuming an old debt has gone away for tax purposes.

If you already filed without reporting a 1099-C, you may need an amended return.

State considerations

States have their own rules for canceled debt. Illinois starts with federal adjusted gross income, so a canceled debt you include federally is generally included on the Illinois return too, unless a federal exclusion applies. See our Illinois guide. Talk to us if you have a large debt cancellation.

How we can help

We review the Form 1099-C, run the insolvency calculation, prepare Form 982 and coordinate with any bankruptcy documents. If you are working out a larger tax debt, see our overview of tax debt relief options. Learn more about individual tax preparation or contact us.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.