What Is Cancellation of Debt and When To Use Form 1099-C

By Ana Gonzalez-Ribeiro, MBA, AFC®
Published on: 03/10/2022

If you’ve run into trouble financially and are having trouble paying your bills, a canceled debt can feel like a relief. But when tax season comes around, that relief can turn into worry. That’s because a discharged debt typically counts as income if the canceled amount is above $600.[1]

What is cancellation of debt (COD)?

Cancellation of debt is when a creditor or lender relieves an individual from some or all of their debt obligations. Cancellation of debt can occur through debt-relief programs, debt forgiveness, bankruptcy, repossession, foreclosure or abandonment of property.

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How does cancellation of debt work?

A cancellation of debt occurs when part or all of your debt is canceled and you wind up paying less than the amount you agreed to pay. Your tax liability applies to whatever you don’t have to pay.[2]

The IRS classifies canceled debt as taxable income because, when a debt is canceled, you wind up receiving a benefit you haven’t paid for.[3] As a borrower, you don’t pay tax initially because you are obligated to pay it back, but once it’s canceled, it becomes taxable income. The money you would have otherwise paid toward the debt becomes yours to do with as you wish.[3] This is referred to as cancellation of debt income.[2]

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Reporting cancellation of debt with form 1099-C

A 1099-C form is a tax document you receive from an individual or business that typically isn’t your employer. You may have received one to submit with your taxes if you received income or payments by working as a freelancer or independent contractor.

You’ll need to file Form 1099-C with the IRS if you have received payments such as prizes, awards, dividends, etc., or if you have received compensation/income earned as a contractor, freelancer or self-employed individual.

Lenders will also provide you with this form if they have forgiven your debt. You’ll need to file it unless your debt fits the following criteria.

Canceled debt that is not taxed

Debt forgiveness that doesn’t count as cancellation of debt income includes canceled gifts or inheritances; loan forgiveness programs to provide health services in certain areas; and student loans under certain conditions. There are also exclusions for things such as qualified farm debt and qualified real property business debt.[2]

If you believe you have qualified exclusions to debt cancellation, you will want to fill out IRS Form 982, which is used to exclude discharged indebtedness under IRS Section 108.[4],[5]

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Filed a bankruptcy case

One exclusion is available to you if you have filed a Chapter 11 bankruptcy case.
Chapter 11 is a section in the bankruptcy code that allows businesses and high-debt individuals to file for bankruptcy protection while they reorganize their debt. It is most typically mentioned in news stories about retailers and other companies that have committed to downsizing so they can pay their debts under a structured repayment plan.[6]

This section of the bankruptcy code allows for the repayment of debt based on future earnings moving forward. It contrasts with Chapter 7, under which assets are sold (a “liquidation bankruptcy”) to repay creditors.

The amount of debt matters: Chapter 11 is available as an option for taxpayers who have more than the limits of $1,184,200 in secured debt and $394,725 in unsecured debt allowed under Chapter 13 reorganization.[7] This is why it’s typically used by businesses and wealthy individuals such as celebrities.


Debts can be canceled to the extent to which the debtor is insolvent.[2] Although the definition of insolvency is complicated, there are two kinds of insolvency under the law. The first, balance sheet insolvency, is defined as when debt liabilities are greater than the debtor’s assets. The second, known as cash flow insolvency, occurs when a debtor lacks the financial liquidity to pay debts when they come due.[8]

For the purposes of debt forgiveness, the IRS looks at the first kind: balance sheet insolvency.

Gifts or inheritance

Gifts aren’t considered debts, even if they were initially borrowed money. Say, for example, you borrowed money from relatives or friends with the intent to pay it back, and they decide not to collect on the debt. It then becomes a gift, on which the recipient does not pay taxes.[1] (Donors, however, should be aware that they typically will have to file a gift tax return for any gift above $15,000 that isn’t to a spouse.)[9]

Canceled bequests and inheritances don’t count as taxable, either.[2]

Student loan forgiveness program

Canceled repayments on student loans that meet certain criteria can qualify as exceptions to taxable cancellations.

Examples include loans that would be canceled if you were to work a certain amount of time in a given field and student loans discharged in response to the death or total permanent disability of the student.[2]

Real estate debt exclusions

A qualified purchase price reduction on a property provided by the seller may be eligible for an exclusion, but there are specific requirements that need to be met. Those requirements include: that the reduction isn’t in response to a bankruptcy or insolvency, and that it doesn’t result in a cancellation of debt income.[10]

Other types of debt include qualified farm indebtedness, qualified real property business indebtedness, and qualified principal residence indebtedness.

If you have received a cancellation of debt as the result of a foreclosure, you only have to report it as ordinary income in cases where you were personally responsible for the entire mortgage, regardless of the lender’s security interest in your home.[11]

In addition, you may be eligible to exclude canceled debt from your tax filing for your principal residence up to $750,000. Under the Consolidated Appropriations Act (CCA), which was adopted as part of COVID-19 stimulus efforts in December 2020, this exclusion for qualified mortgage debt was extended through tax year 2025.[11]

Take taxes into account

Most debt you owe that is canceled, whether it's forgiven debt or discharged, is taxable and needs to be included on your income tax return. Knowing your tax liabilities as well as options for possible exclusions and exceptions will help you safeguard your personal finances after paying off debt.

If you have any questions or are facing complex tax situations, it can help to reach out to a tax professional, preparer or certified public accountant (CPA). Resources are available to help you satisfy the IRS and protect your finances at the same time.


  1. Experian. “What Happens with Canceled Debt?” https://www.experian.com/blogs/ask-experian/what-happens-with-canceled-debt/. Accessed December 29, 2021.
  2. IRS. “Topic No. 431 Canceled Debt – Is It Taxable or Not?” https://www.irs.gov/taxtopics/tc431. Accessed December 29, 2021.
  3. Intuit Turbotax. “When to Use Tax Form 1099-C for Cancellation of Debt,” https://turbotax.intuit.com/tax-tips/debt/when-to-use-tax-form-1099-c-for-cancellation-of-debt/L24iT0a3S. Accessed December 29, 2021.
  4. IRS. “About Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment),” https://www.irs.gov/forms-pubs/about-form-982. Accessed December 29, 2021.
  5. IRS. “Section 108. - Income from Discharge of Indebtedness,” https://www.irs.gov/pub/irs-drop/rr-12-14.pdf. Accessed December 29, 2021.
  6. United States Courts. “Chapter 11 - Bankruptcy Basics,” https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics. Accessed December 29, 2021.
  7. United States Courts. “Chapter 13 - Bankruptcy Basics,” https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-13-bankruptcy-basics. Accessed December 29, 2021.
  8. Legal Information Institute. “Insolvency,” https://www.law.cornell.edu/wex/insolvency. Accessed December 29, 2021.
  9. IRS. “Instructions for Form 709 (2021),” https://www.irs.gov/instructions/i709. Accessed December 29, 2021.
  10. American Bankruptcy Institute. “Cancellation of Debt (COD) Income,” https://www.abi.org/feed-item/cancellation-of-debt-cod-income. Accessed December 29, 2021.
  11. Intuit Turbotax. “How Short Sales and Foreclosures Affect Your Taxes,” https://turbotax.intuit.com/tax-tips/home-ownership/how-short-sales-and-foreclosures-affect-your-taxes/L3itburIV. Accessed December 29, 2021.

About the author

Jeff Smith is the VP of Marketing at Self Financial. See his profile on LinkedIn.

About the reviewer

Ana Gonzalez-Ribeiro, MBA, AFC® is an Accredited Financial Counselor® and a Bilingual Personal Finance Writer and Educator dedicated to helping populations that need financial literacy and counseling. Her informative articles have been published in various news outlets and websites including Huffington Post, Fidelity, Fox Business News, MSN and Yahoo Finance. She also founded the personal financial and motivational site www.AcetheJourney.com and translated into Spanish the book, Financial Advice for Blue Collar America by Kathryn B. Hauer, CFP. Ana teaches Spanish or English personal finance courses on behalf of the W!SE (Working In Support of Education) program has taught workshops for nonprofits in NYC.

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Written on March 10, 2022
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