Debt Forgiveness: What If You Owe the IRS at Tax Time?

If you are having trouble making debt payments, you can ask about debt forgiveness. Learn about how it affects your taxes.
Written by Anna Baluch
Financial Expert
Managing Editor
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A man looks at a bill with a frustrated look on his face.

If you’re overwhelmed with debt, debt forgiveness may be an option. While it may seem like the ideal way to get out of debt, there are some pitfalls to this strategy. As long as you understand what debt forgiveness is and how it works, you can make an informed decision for your unique situation and avoid unwanted financial surprises down the road.

What Is Debt Forgiveness?

Debt forgiveness is exactly what it sounds like. It’s when a lender forgives some or all of the debt you owe them. Depending on your particular circumstances, you may be able to get these types of debt forgiven.

Student loan debt

Your income, job, and the amount of money you owe will all play a role in your options for student loan forgiveness. While there are programs that forgive or cancel student loan debt, they’re difficult to find. They’re usually only available to you if you work in a certain field like public service or education.

If you have federal student loans, you may be eligible for income-driven repayment plans. With one of these plans, you’ll need to repay your debt for 20 or 25 years. Any debt that remains after that time period will be forgiven.

Credit card debt

You may be surprised to learn that credit card companies may forgive or negotiate your balances. If you have a lot of credit card debt, you can work with a nonprofit credit counseling agency to set up a debt management plan or DMP. A credit counselor will reduce your interest rate and consolidate several debts into one payment. This can make it easier and more affordable for you to pay off your debt.

Mortgage debt

The type of mortgage you have will dictate your option for debt forgiveness. If you have an FHA loan, for example, you might have access to the Home Affordable Modification Program. With this program, you may lower your monthly payments and a huge portion of your total loan balance.

The Department of Housing and Urban Development offers several programs like the Hardest Hit Fund® or the Principal Reduction Alternative. If you qualify for one, you may save a great deal of money on your mortgage debt.

Medical debt

Since medical debt is so common, medical debt forgiveness does exist. If you’re struggling with medical debt, you can reach out to the hospital where you incurred it. They may have a financial assistance policy or charity care program that can reduce your bill or even forgive it completely.

IRS Debt

If you owe money to the IRS, a debt forgiveness program known as offer in compromise may help you out. With this program, you can settle your tax debt for less than the full amount you owe.

The IRS will look at your income, expenses, assets, and ability to pay. Then, they’ll decide whether you’re eligible for the debt forgiveness program. If you get approved, you can pay a lump sum upfront or make periodic payments. While the fees and payments for an offer in compromise are nonrefundable, these amounts will get applied to your tax liability.

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Is Forgiven Debt Taxable?

Unfortunately, debt forgiveness is not a magic solution to your debt and does come with some financial responsibility. Any debt that you get forgiven will be considered taxable income. If the forgiven amount equates to more than $600, your lender will need to issue you a 1099-C that states the amount you should report to the IRS.

While you may not receive a 1099-C if the amount is less than $600, you’ll still need to report it on your tax return. If you get a lot of debt forgiven, you may be on the hook for a hefty tax bill. You may even owe more than you originally owed.

What You Should Do If You Have Forgiven Debt

If you have forgiven debt, be sure to do the following.

  • Consult a CPA or tax professional: If you’re unsure of how your forgiven debt affects your tax situation, reach out to a pro for clarity. They can ensure you don’t pay more taxes on your forgiven debt than you need to.
  • Start a savings plan for your tax payment: Since IRS installment plans come with interest and penalties, it makes more sense to save for your tax bill in advance. If you find out you’ll owe taxes on your forgivable debt, create a tax fund and continue to add to it until you have enough.


Are there any situations in which forgiven debt is not taxable?

While most forgiven debt is taxable, there are a few exceptions. If your debt was discharged via bankruptcy, your liabilities exceed your assets, or you borrowed money from loved ones who decided not to collect the debt, you may not have to pay taxes on it. Certain forgivable student loans as well as forgivable farm or real estate debt may also qualify for an exclusion.

What is the difference between forgiven debt and debt settlement?

Debt forgiveness is usually part of a special program and eliminates your obligation to pay some or all of your debt. Debt settlement, on the other hand, often happens when you’re struggling to pay what you owe. It’s also only available for credit cards, personal loans, and other unsecured debts.

Will debt forgiveness impact my credit score?

Unless your debt forgiveness involves bankruptcy, it probably won’t have a negative impact on your credit score. Once your debt is forgiven, however, you should still pay attention to your score. If it’s lower than you’d like it to be, pay your bills on time and keep debt to a minimum as these strategies will increase it.

How does forgiveness differ from forbearance?

Debt forgiveness gets rid of your debt. Forbearance, however, is more of a short-term form of debt relief as it postpones your payments. If you qualify for forbearance, you’ll still need to repay the debt that you owe eventually. Forbearance programs are usually available if an event like a natural disaster, major illness, or job loss affects your ability to pay.

About Author
Anna Baluch
Anna Baluch is a personal finance writer and expert who writes about financial topics ranging from personal and student loans to mortgages, debt relief, auto financing, and budgeting. As a contributor to MoneyRates, Anna’s insights are backed by her hands-on experience, exemplified by her achievement of paying off her mortgage in just 16 months, a journey she shared on the “Burn Your Mortgage” podcast in 2019. Her knowledge and expertise have appeared on personal finance platforms such as LendingTree, Business Insider, Credit Karma, Experian, American Express, Rocket Mortgage, U.S. News & World Report, and Policygenius. Anna is dedicated to guiding consumers toward making informed financial choices.