What Are the Tax Implications of Debt Settlement: A Guide | Axiom Tax Resolution Group

Essentially, a debt settlement is an agreement between you and your creditor to pay off your debt for an amount that is less than what you owe. This can be a good option for people who are in over their heads with their debt, but it is not without its difficulties. One difficulty is that it will likely damage your credit score, as it will be recorded as a debt that was settled for less than the full amount. Additionally, you may be required to pay taxes on the amount of forgiven debt.

What Is Debt Settlement? 

In a debt settlement, the creditor and borrower agree to a reduced amount that will be used to pay off the debt in full. This is beneficial for the borrower because they will end up paying a smaller amount than what they originally owed, and the creditor will receive at least partial payment instead of having to write off the entire balance.

Debt settlement is a process where you negotiate with your creditors to pay less than the full amount you owe. This will appear on your credit report and might hurt your credit score. You may also have to pay taxes on the difference between what you paid and what you owed.

What Are the Tax Implications?

If you settle a debt, you may have to pay taxes on the amount of debt that was canceled. The creditor may send you a 1099-C cancellation of the debt tax notice. The information from the notice will be reported to the IRS, and you will need to report the canceled debt as other income on your tax return. 

There is an exception for student loan debt forgiveness: The American Rescue Plan that President Biden signed into law in March 2021 exempts student loans forgiven through December 2025 from being considered gross income. If you owe taxes on canceled debt, there are a few options for relief. You may be able to have the debt forgiven if it meets certain criteria, or you may be able to negotiate with the IRS to lower your tax bill.

How Much Is the Tax?

The income tax rate in the United States is based on a person’s taxable income. The tax rate increases as the taxable income increases. The highest tax rate is 37 percent for 2021.

What Happens When You Don’t Report It?

You are required by law to report any taxable income you receive, including money from a debt settlement. If you are issued a 1099-C form, the IRS is also notified of the income, and you could be fined if you do not report it. In addition to the taxes you owe, you may also have to pay penalties. If you don’t receive a 1099-C, the IRS won’t be aware of this income. However, if you’re audited for any reason, the IRS will likely discover this income. It’s not worth breaking the law by underreporting your income.


The tax implications of debt settlement can be complicated. Depending on the circumstances, some or all of the debt may be considered taxable income. Sometimes, the amount of the debt forgiven may be considered taxable income. In addition, any fees associated with the settlement may be deductible. If you are considering debt settlement, it is important to speak with a tax professional to discuss your specific situation.

Axiom Tax Resolution Group is a team of tax resolution services specialists. Ignoring IRS tax problems can be a costly mistake. The trusted tax professionals at Axiom Tax Resolution Group are ready to find a permanent solution to your tax problems with the IRS. If you need a tax resolution specialist, we’ve got you covered. Get in touch with us today and let us know how we can help.