Taxes on Debt Settlement

Debt settlement can help to reduce the amount you pay to creditors, but it is also important to understand how it can affect the taxes you pay.

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When you have accumulated overwhelming amounts of debt and use debt settlement to pay them off, that should make the pesky old bills go away for good … right?

Not necessarily.

Unfortunately, you might have another expense to cover after you settle a debt: federal taxes on debt settlement. That’s because the IRS may treat the amount you don’t pay — the canceled amount — as income.

When you’re negotiating a debt settlement, creditors don’t usually tell you about this final step in becoming free and clear of the bill! But you can find a rundown on the tax ramifications, and some of your other options for managing debt, below.

What Is Debt Settlement?

Debt settlement describes the act of negotiating with a creditor or debt collector to pay off a debt for less than you owe. If you’re confused about the topic of debt settlement, it’s because this term is used to describe several very different things.

But debt settlement, or “debt relief,” also describes a predatory, for-profit industry that claims to negotiate debt on customers’ behalf. If you choose this route, you have to hand over control of your debt accounts to the for-profit company. You also send them money, some of which is eventually offered to your creditors.

Finally, there’s also nonprofit debt settlement, which is available through credit counseling agencies that help consumers deal with credit card debt and other financial challenges. When you go this route, the creditor agrees upfront to accept 50%-60% of what is owed, and there is no negotiating. Payments are spread over 36 months and no interest is charged.

Do You Have To Pay Taxes on Settled Debt?

Unfortunately, settling a debt may not be the end of your financial obligation.

Depending on the type of debt and the amount of money that’s forgiven/discharged, the IRS may view the unpaid debt as income, which means you have to pay income taxes on debt settlement. This happens when you have $600 or more of debt canceled.

As an example, let’s say you have a $1,500 collection bill and you only pay $900 to settle the debt. That means you’ll have $600 canceled. Next, the creditor may need to send you a tax form (1099-C) with information that’s useful for filing your taxes. But even if they don’t send the form, you may still have to report the $600 as income.

What Is a 1099-C Form?

If a federal government agency, financial institution, or credit union cancels at least $600 in debt, they may have to file a 1099-C form with the IRS.

If you receive your copy of the form, you can use it to locate valuable information for your personal records and for tax filing. The form will include:

  • Creditor’s name, address, and phone number.
  • Amount of debt canceled.
  • Date of cancellation.

How Much Tax Will You Have To Pay on Settled Debt?

You should expect to pay the same income tax rate for settled debt as you pay on your income. For example, if you’re in the 22% income tax bracket and have $600 worth of canceled debt, the tax bill would come out to $132 ($600 x 0.22).

Here are some more examples:


Estimated Taxes on Debt Settlement (based on 2023 income tax brackets)
Canceled Amount12% (income over $11,000)22% (income over $44,725)32% (income over $182,100)

Can You Avoid Paying Taxes on Canceled Debt?

You usually can’t avoid paying taxes on canceled collections and most other debt. On the other hand, some debts don’t involve a tax bill when they’re canceled. Here are some exceptions to be aware of:

Debt Settlement Tax Exceptions

The debt that’s least likely to be taxed when forgiven is federal student loan debt. You won’t have to pay taxes when your loans are forgiven because you completed a work requirement or provided a public service (like PSLF).

Examples of canceled debts that won’t be taxed:

  • The debt is canceled as a gift.
  • The debt is canceled in a bankruptcy.
  • Student loan debt forgiven as part of the PSLF program.
  • Student loan forgiveness from income-driven repayment plans is tax free through 2025.

If you’re not sure whether your canceled debt will be taxed, consider talking to a tax professional like a CPA or tax attorney.

Tax Implications of Debt Settlement vs. Bankruptcy

If you’re wondering how to avoid taxes on debt settlement, bankruptcy might seem like a good solution. But bankruptcy is worth considering carefully since there are important differences between bankruptcy and debt settlement.

Here are some outcomes you can expect when filing bankruptcy instead of settling your debt:

  • Some of your debt may be canceled, but the canceled amount is not taxable.
  • Creditors must stop taking action to collect your money and property once you file.
  • Bankruptcy can stay on your credit reports for seven to 10 years.
  • You have to qualify to file Chapter 7 bankruptcy based on a means test.
  • Student loans can’t usually be included.
  • You may have to pay court fees and lawyer’s fees.

Speak to a Credit Counselor for Help

Still not sure how to tackle your debt? A certified credit counselor can help you navigate the complicated landscape of debt settlement, bankruptcy, and everything in-between.

When you meet with a counselor (either in-person or by phone), they’ll ask questions about your income, debt, and credit, give you professional advice, and recommend the solution that makes most sense for your circumstances. And the best part is that many credit counseling services are free.

About The Author

Sarah Brady

Sarah Brady is a Personal Finance Writer and educator who's been helping people improve their financial wellness since 2013. Sarah writes for Experian, Investopedia and more, and she's been syndicated by Yahoo! News and MSN. She is a workshop facilitator and former consultant for the City of San Francisco's Affordable Home Buyer Programs, as well as a former Certified Housing & Credit Counselor (HUD, NFCC). Sarah can be contacted via


  1. N.A. (ND) Publication 525 (2022), Taxable and Nontaxable Income. Retrieved from
  2. N.A. (ND) Topic No. 431, Canceled Debt – Is It Taxable or Not? Retrieved from
  3. N.A. (2022, October 18) IRS provides tax inflation adjustments for tax year 2023. Retrieved from