You Settled the Debt. Then the IRS Sent You a Bill.
Here is the part almost nobody mentions when they are selling you a debt settlement program. If a creditor forgives part of what you owe, the IRS generally treats the forgiven amount as income to you — as though someone had handed you the money.
Settle a $50,000 debt for $25,000 and it feels like a win. Then a 1099-C arrives for the other $25,000, and the IRS’s position is that you earned it.
The IRS states it plainly: “In general, if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable.”
That is genuinely frightening the first time you hear it. But like most things in this business, it gets much less frightening once you understand how it actually works — and there is a specific form that lets a lot of people out of it entirely.
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The Insolvency Test: The Escape Hatch Most People Never Hear About
Cancelled debt is not taxable to the extent you were insolvent when it was forgiven. Insolvent has a precise meaning here, and it is not a feeling about your finances:
- Add up everything you own — checking and savings, investment accounts, retirement accounts, vehicles, home equity.
- Add up everything you owe — mortgage, credit cards, student loans, personal loans, remaining car loans.
- Compare the two immediately before the debt was cancelled — that is the IRS’s operative wording, not the date you noticed.
If your liabilities exceeded your assets, you were insolvent by that difference, and the cancelled debt is excluded from income up to that amount.
The Trap: The IRS Counts Your Retirement Account
This is where people get caught, and it is the single most useful thing in this episode. When Damon Day and I walked through it live on the show, the numbers that sank the example were not the checking account — they were the retirement account and the investment account.
People assume their 401(k) does not count because they cannot touch it without a penalty. For the insolvency calculation, it counts. So does the car. Someone who feels broke on a month-to-month basis can still be solvent on paper, and owe real tax on forgiven debt.
You can run your own numbers with my free 1099-C Calculator — no email, nothing to buy.
Form 982 — And Why Your Tax Preparer May Not Know It
If you qualify under the insolvency rule, you claim it on Form 982, attached to your return. The IRS requires it: “You must report the amount qualifying for exclusion, and any corresponding reduction of those tax attributes on Form 982…and attach to your tax return.”
Two things about that sentence matter.
First, plenty of tax preparers have never handled one. Damon’s advice when a preparer does not know what Form 982 is: get a new tax person. That is not snobbery — it is a several-thousand-dollar difference on a form the IRS publishes for free.
Second, note the phrase “corresponding reduction of those tax attributes.” The exclusion is not quite free money. If you exclude cancelled debt from income, you generally have to reduce certain tax attributes — things like loss carryforwards and the cost basis in your property — and for many people in genuine distress, with no business losses to give up, the reduction lands on the basis in personal property such as a home or car. For most people in genuine financial distress this is a good trade, but you should know it is part of the deal rather than discover it later.
Keep Your Records — for Years
The insolvency claim is yours to prove if the IRS ever asks. That means documenting what you owned and what you owed immediately before the debt was cancelled, and keeping it.
Five years from now you will not remember what your house was worth or what your card balances were. If you cannot show it, a legitimate insolvency claim can fall apart on paperwork alone. Save the statements when you file, not when you get audited.
One More Thing: Your State May Not Follow the Federal Rule
Everything above is the federal treatment. States do not all conform to it — some follow the federal exclusions exactly, some partly, some not at all. It is entirely possible to exclude cancelled debt on your federal return with Form 982 and still owe state income tax on the same amount. Check your own state before you assume you are clear.
Bankruptcy Is Treated Completely Differently
Here is the contrast that surprises people most. Debt discharged in bankruptcy is not cancellation-of-debt income at all. The IRS lists “Debt canceled in a Title 11 bankruptcy case” first among its exclusions.
So the same $25,000 that can generate a tax bill when settled generates none when discharged in bankruptcy. Same debt gone, entirely different tax outcome. (Tax attributes still get reduced, as with insolvency.)
Neither Damon nor I earn a dollar if you file bankruptcy. We keep raising it because almost nobody else in this industry will, and because a settlement plan that quietly hands you a tax bill at the end is not the bargain it appeared to be on the phone.
Two 1099-C Situations Worth Knowing
You know debt was forgiven, but no form arrived
Not receiving the form does not mean nothing was reported. And the IRS goes further than that: you are required to report cancelled debt as income even if no 1099-C ever arrives, unless an exclusion applies. Its own guidance is explicit — “Even if you didn’t receive a Form 1099-C, you must report canceled debt as gross income on your tax return unless one of the exceptions or exclusions described later applies.” Waiting for paper is not a strategy.
There is also a threshold worth knowing: creditors are generally only required to file a 1099-C for cancelled debt of $600 or more. Below that, no form may ever exist — and the debt can still be taxable income.
The form is simply wrong
Sometimes a 1099-C lands for an old debt and the amount or the year is wrong. Getting it corrected can be, in my experience, close to an act of God. Occasionally the juice is not worth the squeeze — but make that a decision you take deliberately, with the numbers in front of you, rather than one you default into.
What You Can Do Right Now
1. Ask about taxes before you sign anything
If a settlement company has not raised the 1099-C with you, ask directly what your tax exposure will be. The answer changes the real cost of the program.
2. Run the insolvency numbers now, not in April
You need a picture of your assets and liabilities as of the forgiveness date. Use the 1099-C Calculator and save what you enter.
3. Ask your preparer about Form 982 by name
If you get a blank look, find someone who has filed one.
4. Compare paths on after-tax cost
Settlement with a tax bill and bankruptcy with none are not the same deal, even when the debt eliminated is identical. Compare what you actually walk away owing.
This Show Is For You
Damon Day and I put out a new episode weekly, and we spend it on the parts of this that the sales calls skip. You can reach Damon at damonday.com.
And if you want to think it through with someone first, ask me. It is free, it is private, and I sell nothing.
I am not a tax professional and this is not tax advice. It is the plain-English version of how the rules work, so you can ask better questions of someone who is.
Dealing With Debt? Understanding your options is the first step. See how all your debt relief options compare — including ones most sites won’t tell you about. The Find Your Path quiz gives a recommendation based on your actual numbers, and the Scam-O-Meter checks any company’s complaint history before you sign. Federal Reserve Bank of New York research shows bankruptcy filers recover faster than those who don’t file.
Key Takeaways
- The IRS generally treats forgiven debt as taxable income — settle $50,000 for $25,000 and the other $25,000 can land on your tax return.
- Cancelled debt is excluded to the extent you were INSOLVENT when it was forgiven: total liabilities greater than total assets on that date.
- The insolvency calculation counts your retirement account, investments and vehicles — which is exactly why people who feel broke still owe tax.
- Form 982, attached to your return, is how you claim the exclusion. Many tax preparers have never filed one; that is a reason to change preparers, not to skip the form.
- The exclusion is not entirely free — you generally must reduce tax attributes such as loss carryforwards and property basis.
- Debt discharged in bankruptcy is NOT cancellation-of-debt income at all. Identical debt eliminated, completely different tax outcome.
- Document what you owned and owed on the forgiveness date and keep it — an insolvency claim you cannot evidence years later can fail on paperwork alone.
Full Transcript
Click to expand transcript
Opening
Hey, you're back with the Get Out of Debt Guy show. I'm Steve Rhode. The original Get Out of Debt Guy. With me, as always, is Damon Day, the probably more attractive but definitely younger new Get Out of Debt Guy. Hey, Damon. Probably?
What are you talking about? How's everybody doing? Well, here's something almost nobody talks about when they talk about getting rid of your debt or debt settlement. The IRS considers forgiven debt to be taxable income. Yeah, like you just made it. That means if you settle a debt for 50 grand for 25,000, which seems like a deal, the IRS will say, Hey, you made 25 grand on that deal, and you could owe taxes on it.
It sounds scary. Looks like you made it. Well, and the problem is that a lot of debt settlement companies never explain that as a side effect, and it can be scary. But like most things, it's less scary when you understand it, and we're going to help explain that today. And we're going to break down the tax implications of debt forgiveness so you can plan wisely and smartly. But before we jump into that, Damon, you have been picking out three of your favorite stories that I've written on the site in the past week, and I have been a posting fool.
Yeah. So what is number one for you? And I clearly have the hardest job of the two of us because you write it all, but I have to pick them. Yeah, you're telling me you read them all? Uh, skim, yes. Well, that's the problem.
I mean, I've been writing really detailed— Oh, hold on. We're literally just talking about that before. Yeah. If it's not my wrecking ball, it's your warning wife. Thanks, Pam. Hey, honey, we're on the podcast.
What's up? This is a high-dollar production we've got going here. Well, she was at the store, wanted to know if I needed anything. Absolutely. I need you not to call me during the podcast. That's what I need.
Steve and I were literally talking about that before we went on air because Kathy interrupted our podcast last week. Last time, yeah. Yeah, with the come in like a wrecking ball, you know, ringtone. And then I hadn't heard Pam call in a while, so I was like, Do you still have that warning? It's the wife. And he goes, Yep, and there it was.
It's the wife. Well, just to show how— Hide your wife. Just to show how authentic this is, I'm not going to edit that out. Yeah, just leave it in there. Yeah. Coming like a wrecking ball.
You were saying. I was saying how my job is always the hardest because I have to pick the stories.
Bankruptcy and Your Security Clearance
So the first one we're going to talk about, mainly because I had somebody call in and they had a situation where they were worried about their security clearance, and, you know, they had some debt they had to deal with. And obviously, if your security clearance is tied to your income, that's a big concern. You don't want to cut off your nose to spite your face. So whatever you do, if you've got debt and you have a security clearance, you want to make sure that the solution that you're looking at is not going to affect that security clearance. And Steve has written a great post. So if you have debt and you have a security clearance, I highly recommend you go to the GetOutOfDebt.org site and just type in, Will I lose my security clearance if I file bankruptcy?
And the answer, Steve, is— No. I thought you were going to hedge it a bit because all situations are unique. I thought he was going to say, like, not very likely, so I'm going to throw that in there. It's possible, but not very likely. The funny thing is that years ago, I had a client who was actually responsible for the whole security clearance thing at a government agency, and he was one of my clients. And he told me, I said, Aren't you worried about that?
He goes, No. Yeah. So that was like 20 years ago. Even back then, it wasn't a thing. But the funny thing is that people won't know, and this is going to be a little behind-the-scenes information, is we actually tried to do this podcast yesterday, and Damon was sitting in a parking garage at a hospital in California, and he observed, before we had to break it off for bad connection, that there is a statistic in this post that is about 5,000 words long. Damn it, I sat down and I wrote the most definitive post ever on this security clearance and bankruptcy, and you observed yesterday that there's a statistic in here: people that Steve and Damon have seen lose a job to bankruptcy.
And the answer is, after our collective, I don't know, 50 or 60 years, no. None. Yeah. Zero. Yeah. And I will quantify that.
There have been a couple of people that, you know, it wasn't a security clearance issue, though. It was a separate issue, like a financial licensing and things like that, where they found out that it was possible that they could lose some clients if they had a bankruptcy, so they opted not to go that route, which is fine. But again, it's all about gathering the information. And, you know, if you find out that you're going to cut off your nose to spite your face, you don't go that route. But it's just about getting the right information. But most of the time, and Steve, why is it that, you know, people are afraid of the bankruptcy potentially affecting their security clearance, which would, of course, affect their livelihood?
Why is it that they shouldn't really be afraid of the bankruptcy, but something else? Yeah. So if you work for an agency or a company that is concerned about your finances and is looking for security issues, and one of the biggest security issues is, hey, are these balances growing? Are they getting near their limit? You know, are they taking on too much debt? You don't need bankruptcy to figure that out.
They can regularly monitor your credit report. If you have signed a waiver when you first became employed or joined the company that allowed them to monitor your credit report, they're doing that. So you stand at a greater risk. And here's the ridiculously stupid thing is that if you go to the security officer, you can have a confidential conversation about it and go with a plan and say, look, this is how I'm going to deal with the situation. I mean, like, let's just take the high-security folks, like military services. Like the Army says specifically, this is a quote in the post, filing for bankruptcy does not disqualify a soldier.
It shows that you are actively working to fix the finances and it demonstrates responsibility. Because let's not forget, bankruptcy is a legal tool. This isn't some fly-by-night, hope to hide it. You are following the law. It's written in the United States Constitution. And again, the Army says, acting responsibly with regard to indebtedness is a positive course of action and will not result in the denial, loss, or suspension of a security clearance.
Yeah. So the irony is, if you are, you know, listening to this podcast or you find the article on the getoutofdebt.org site, and you're in a situation where you're even asking yourself the question if a bankruptcy is going to affect my security clearance or, you know, settling my debt is going to affect my security clearance, the irony is you're already in a situation that could affect your security clearance. Right. Right. So it's not so much, you know, and when you think about why would that potentially affect my security clearance, the reason these rules are in place is because they want to make sure somebody is not in a financially compromised, or compromising, or what's the word I'm looking for? Compromisable.
Well, yeah. I mean, they're looking for people who could not be easily manipulated. Yes. So when you really think about it, if you're in a situation where you're stressed, your debt is maxed out, you're about to fall behind, you're worried about losing your clearance, you don't know what to do, you're emotional, you're not thinking clearly because you're stressed out about all of this, you're in a vulnerable situation to where you might make decisions and do things that under normal circumstances you wouldn't do, right? And that's what they're worried about. So when you think about it, a bankruptcy actually removes you from that potentially compromised situation.
It wipes out all that debt. It takes away all that stress, all that leverage, if you will, for you to maybe do something for something that you wouldn't normally do. So the big thing is you have to be upfront with it and, like Steve said, come up with a plan first. And then when you go talk to your security officer, hey, here's what's going on. Here's how I got in this situation. Here's what my plan is to deal with that.
How is that going to affect me? And you could have that confidential conversation. And maybe if you find out, well, no, you can't do this. It's not going to look good. What about this, this, or this? Well, then you can talk that through.
With your security officer, show you're doing the right thing. Right. And there are, so for example, what about people that have professional licenses? So the state bar for attorneys, of course, says it is not an automatic disqualifier. Right. Medical licenses, the state medical boards cannot revoke licenses solely to bankruptcy.
Nursing licenses, same thing. CPA certifications, you have to disclose it, but does not automatically result in revocation. Real estate licenses, it's protected from your real estate company checking your credit without your permission. And if you do have a limit at all, it might be on a limit on holding client funds during proceedings, but your agency can hold those for you. Now, if you have a security license like a Series 7, it must be disclosed, but it does not result in automatic license loss. So the problem is, over the years, I've seen so many people that have been afraid of this and have avoided it and said, I absolutely can't consider it.
And what does that leave them in? A more compromised situation, potentially facing a suit and a wage garnishment. The debt stress they have to deal with is going to affect their job performance, and the security vulnerability is ongoing anyway. So neither of us are saying go file. What we're saying is take a breath, a brief, take a breath, yeah, take a breath, take a beat, and, you know, you can always reach out to Damon and discuss your individual situation. You can reach him at Damon Day, D-A-M-O-N D-A-Y dot com.
And be happy to answer your questions. Same bat time, same bat channel. Yeah. What would your bat signal be? Be like, what, a giant dollar sign in the sky or something? Yeah, sure.
Why not? Yeah. All right. Article number dos. Yes. Okay, so this one is a good one because it comes up a lot.
In fact, a lot of these articles are me having a conversation with an individual and going, Oh, that's an interesting situation, and then I tell Steve about the situation, like, Oh, I had somebody call me and they were in this kind of situation, and he goes, Ah, idea for an article. And then before I hang up the phone, there's a new article. Yeah. So this one— Now, you didn't mention this to me, but this is the one I'm working on right now that'll probably come out today, is Poshmark addiction and debt. So, I mean, I'm always thinking about this shit. Well, I know for sure I didn't mention that to you because I have no idea what the hell Poshmark is.
Yeah, it's another one of those sites where you sell shit. Oh, it's a new Fandango site, like a Whatnot or something like that? Yeah, it's a resale site. Poshmark. Poshmark. You're posh.
If you— yeah. Anyway, but Damon did mention the security clearance, and I had an old post, and that's why I went in and refreshed the whole thing. But number two is which one?
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Debt, Marriage and Financial Infidelity
Is debt and marriage: the complete guide to financial infidelity, hidden debt, and recovery. And the reason I wanted to highlight this one on the pod, as they say, is because this is very common. This is very, very common. I get a lot of phone calls and all kinds of situations, but, you know, money issues are one of the number one reasons for separation and divorce. And so this is an issue that is very important, and it's something I see on the daily. Where you'll have one spouse calling me and this spouse doesn't know about it, or they're aware of it and they're pissed, or, I mean, there's any myriad of situations.
But this is a really, really good post. And, you know, having debt, especially if you have debt that your spouse doesn't know about, is not the end of the world. It's solvable in most cases. But the worst thing you can do is just continue to try to hide it and solve it yourself in the dark, hoping they never find out about it, because they always find out. They always do. She doesn't know about it yet.
Warning, warning. It's the wife. It's the wife. Oh, believe me, the husbands are, you know, just as guilty. And this particular— Dude, that was my joke because of the beginning of the podcast with your— Yeah, no, I got it. I'm not saying it's always the wife.
Warning. Danger, Will Robinson. Well, so statistically, women spend more but smaller amounts, and men spend more but in less frequent, bigger purchases. Well, women only buy things on sale, so that's fine. Okay. What'd I say?
What? Yeah, only things on sale. I can see my wife looking at me through two walls. No, we made money on this because it was on sale. Sale. Oh, good.
Okay. Awesome. So this post, Debt and Marriage, it links to seven other posts that I've written on this subject, and one of them is a clever title I came up with years ago that really describes— Because I talk about financial, I mean sexually transmitted debt. And that's exactly the way this goes. I remember when you came up with that, you were so proud. I know.
You're like, Dude, that is so clever. I know. It's still an STD. It was like 15 years ago. I remember you calling me up and going, Oh, you got to see my latest article. It's on sexually transmitted debt.
And I was like, Yeah, huh? What are you talking about? Yeah, let's not just say financial infidelity. Let's talk about the real STD here. Yeah. So the, I don't know how deep we want to go into it, but look, it's human nature.
Savers attract spenders, and we've talked about it before about all the reasons why that happens and everything else. But you get two people talking different financial language. Your money personality really dictates how you think about and deal with money. And if you go to getoutofdebt.org, at the very bottom, you can find a link in the free tools section to the money personality quiz, and you can answer those questions and get an answer about, you know, what is your unconscious money personality or your partner's, and that'll help you understand, you know, why they might be coming from one situation or another and dealing with it differently. I remember a couple, I've talked about them before, where they were sitting in front of me in the office, and the husband was yelling, yelling at the wife, Stop spending! Stop spending!
And then, like in a moment of crystal clear honesty. He again said, Why can't you stop spending? And she turned to him and, because she was spending on the kids. Yeah. And she turned to him and said, Because the kids show me they love me. It's like, damn.
You know, it wasn't about the spending at all. It was about this relationship issue that they had never talked about. Did you lean back in your chair after that, put your fingers together and be like, Tell me about your father. Yeah. No, I think I would go on. And then?
No and then, no and then. No, but that opened up a whole conversation and things cooled off. And yeah, once they started to understand where they were each coming from, because we've always said it, that debt is the symptom. You know, it's the crap that's left behind. Yeah, and that's true. Yeah.
And I, ever since two weeks ago, I feel the need to, like, make this disclosure.
We Are Not Here Pushing Bankruptcy
We talk about bankruptcy a lot, but we're not saying the solution to everything is filing bankruptcy. And I've got a little, little, what's the word I'm looking for now? Not a phobia about it now all of a sudden, but I had somebody call me— Chip on your shoulder? —on the podcast, something, and he was explaining the situation. He goes, Well, you're probably just going to recommend bankruptcy or something like that. And I was like, Well, no, I don't know yet.
And he goes, Oh, well, you know, I've listened to your podcast, and you guys talk about bankruptcy all the time, so I just kind of assumed you think, you know, everybody should file bankruptcy. And it kind of was like, Huh. No, we do talk about bankruptcy a lot, but that is absolutely not the message we want to be sending. So again, when we talk about bankruptcy, it's as an option to be explored with a lot of other options. So don't assume if you go to damonday.com and request a consult with me that I'm just going to listen and go, Okay, okay, yeah, bankruptcy, right? It's not like that, right?
It's an option that we look at, but we look at everything. And the reason we talk about bankruptcy so much is because nobody else ever does. So people just get this in their head that bankruptcy is a last resort, and they don't even explore it until they usually waste a whole bunch of time and money doing things that make absolutely no sense. As a matter of fact, I just got a help request yesterday. I haven't talked to this gentleman yet. But they hired a debt settlement company, who shall remain nameless on this podcast for this story.
Thank you. But, yeah, but they, you know, he hired them, and they settled some of his debts, but now he's saddled with this large loan that is high interest that he can't pay off that the debt settlement company convinced him to get. And now his situation is changing. He's an older gentleman. He's in his 70s, and he's going to stop working. Now, of course, this must have never come up on the interview process about their five-year plan for him to, you know, resolve his debts, but he was only going to be working for another year or two.
Must have slipped their mind to really kind of dig into that situation. And so now he's wondering what to do because he still has this large payment every month that he can't afford to this high-interest loan that he got for these, you know, these debts that he settled at the behest of the debt settlement company. So, and then at the end he goes, I don't want to file bankruptcy. Now, I don't know why. Maybe he can't. Maybe there's a non-starter.
I'm not sure. I'll find out. But it just goes to show you that you have to look at all your options ahead of time because he may be in a situation where he has wasted not only valuable time during his last remaining working years not solving the problem, but also what sounds like thousands and thousands of dollars on a solution that might doesn't sound like it's going to solve his problem. So it's important that you realize that no matter how bad you think things are right now, it's almost never an emergency. It's almost never a, I have to have an answer in the next hour. I need to know.
You're not on fire. Not on fire. Yeah, you've got time to take a step back, really look at all the different options, and that's what I do with clients, is we go over everything to make sure we're making the right decision the first time before we waste time and waste a whole bunch of money going, Huh, yeah, that didn't work. I should have thought about that ahead of time, but oh well. So again, we're not here pushing bankruptcy. We're pushing look at everything.
That's what we push. Yeah. So again, you know, of the 20-something free tools I have on the getoutofdebt.org website, one of them is the—yeah, that's for today. I'll get some more time tomorrow. One of them is your brain on debt, which I think is a fascinating quiz because if you take it— It'll show you why just brain chemistry, biologically, your thinking is so tunnel visioned that you're just not seeing all the options that are out there for you. I had somebody that came—I don't think it's the same dude.
I had a guy come into the Ask Steve chat on the site, and he was 72 years old, only on Social Security, and some debt relief company was putting him in a settlement plan. No, I think that's a different one, because this one has already been in the settlement plan for a while. Oh no, yeah, so it's different. But it happens very frequently. You know, Damon and I have talked over the many years about why—why was this person proposed? If you're on Social Security only, do not call a debt settlement company.
There's no scenario where it's going to be like, Oh, you're bringing home $2,500 a month and you're trying to eat too. Okay, let's set aside 500 bucks a month out of that, and let's pay off this $50,000 in debt when you're potentially judgment-proof, you know, no assets, Social Security is protected. Just call me. If you're on Social Security only, just call me first. We'll figure out some real solutions so you're not, as Steve says, deciding whether you like or prefer dog food versus cat food when you're in your 80s, right? When you get to a certain age, you're on Social Security, you know, paying a creditor back is not your number one priority, regardless of what your creditors think or the debt settlement company tells you.
Now, I got a bunch of shit for this like five years ago or something, but a national credit counseling group had put out a press release about their client of the year that they were so proud of. Oh, I remember this story. Yeah. I mean, it was a woman who went to the credit counseling agency and worked out a budget and then went back to work to work on her five-year repayment plan. But her husband had early onset dementia. Yeah.
And so she's now out of the house, away from him while he's losing his mind, to repay her debt, maybe if she's going to make it five years. Who knows what his medical care is going to be, and how in the F is that the client of the year? That's like the worst advice of the year client. Yeah. Why spend your remaining time with your husband while he, you know, you can have those time and memories instead of you out there working some job. Yeah.
And, or if you were going to get the job, you know, anyway, right? Why not look at maybe filing the bankruptcy, wiping out the debt, and then if you were going to work the job regardless, at least that money could be saved towards his eventual care. But more importantly, maybe you don't have to work the job at all. You know, we only get one shot at this life, right? So you choose how you want to spend it. You know, what's happened in the past, what you've spent money on, the decisions you've made, that's in the past.
There's nothing you can do to change it. All you can decide to do is, what can I do to do better moving forward?
Your Creditors Already Expected You Might Not Pay
And that should segue into this last article that I wanted to bring up, which is your creditors already expected that you might not pay. Here's what that means for your options. And Steve, give me a good summary of what this article is about and why it's important that everybody read it, because this is the biggest thing that I see of the shame, the I need to repay my debt no matter what. Well, shame makes a great tool to poke people to collect debt. You know, debt collectors will use shame all the time. Now, so the title…
Your creditors already expected you might not pay. Here's what that means for your options. Again, we are not saying just don't pay your creditors. What we're saying is, let's give you some insight, and we give all this information so that you can take it and help you to make better, clear-thoughted — if that's a word. Sure, go with that. Well, okay.
Clear-thoughted decisions based on your situation instead of this particular cultural myth that people have about being judged as a moral shame or a moral failure or whatever. You know, let's talk about interest rates, for example. So the interest rate is what creditors use to compensate for risk. So if they lend to a lot of subprime people, the interest rate for those people will be higher because, mathematically, they already know that a certain percentage of people are just not going to be able to repay their debt for a whole host of reasons out of their control. And so that is already factored in to the cost of the interest rate. The higher your credit score, the lower your interest rate, because that credit score is an attempt to monitor what your risk is for them to lend to.
So creditors are already building that in to that interest rate that you're being charged. Credit cards, as an industry, are already enormously profitable. And moral framing is a deliberate collection strategy. So don't run off the rails thinking anything about your creditors. Ultimately, and I'm not saying this, again, as permission to not pay your debts, but ultimately, let's put into context what you really are to your creditors. You are a line on a screen.
You are next. You know, if you can have the credit card taken away because you spoke poorly to a customer service person— American Express. You are— I hate to say this, I don't want to burst your bubble, but, you know, each of us are really nothing to our creditors but a money-making machine. Yeah, you've got permission to give morality that you receive back when it comes to your creditors. I mean, what kind of morality are they giving back to you? It's a very different story if you could just call up your creditor and be like, Hey, man, I lost my job.
You know, I'm really struggling right now, and what can you do to help me out? I really want to pay this back, but I don't have the money right now. Yeah, don't worry about it. What kind of morality and compassion do you get from your creditors if you have a life event and they don't give two shits about what your situation is? So is it your fault if we can figure out, well, this is how the system works, so I'm in a situation where I have to look out for my family first. My creditors aren't going to look out for me, so I'm in a situation where I'm not going to put them above my kids.
Fuck them, right? Again, we're not saying just go charge up a whole bunch of debt and then tell them to piss off, but if you're in a situation where you're having to choose between a roof over your family's head and paying a credit card monthly payment that month, don't make the wrong choice. There should be a clear choice, and don't struggle with the morality of that because we didn't create the system. The banks did. It's not my fault that you have to be behind on payments before they'll show quasi-compassion and potentially be agreeable to a more affordable deal. I didn't create that scenario.
You didn't create that scenario. The bank did. So that's not your fault. So don't feel bad about it. Debt collector calls you and says, You made a promise to pay. You have a moral obligation to repay this, and you feel shame and stress and everything else.
At the very same time, Neiman Marcus files bankruptcy. Their stock goes up, and they get larger lines of credit. Yeah. Well, you know how to checkmate the creditor, collector calling and shaming you? Well, I did by asking for recipes, but what is your choice?
Never Get on the Phone Without a Plan
Don't answer the damn phone. Simple. They can't shame you. They can't talk to you, right? It's simple. Don't get on the phone with a debt collector until you know what to expect and have a plan.
Do not get on the phone with a debt collector thinking, I'm going to tell them what's going on. They're going to feel bad for me. They'll pretend to feel bad for you, right? Yeah. And then it's just them gathering information. Whatever you say can and will be used against you later.
So the best approach, if you have debt and you've got you're behind and creditors are calling, do not answer the phone. It doesn't work like you don't answer and they sue you. It doesn't work like that. No, you're better off not answering the phone than you are picking up the phone and yelling at them. Ah, well, so yeah. Yeah.
So a collector back in my day told me, you know, if I'm talking to somebody and they say they can't afford to pay, he goes, I'll ask them, Well, can you make a promise to pay next week? Yeah. And they'll make that promise to pay next week to get me off the phone. And when they miss that payment, we'll use that against them. They have no intention on paying this back. Do not get on the phone with the collector if you're behind unless you know what your strategy is going to be and already know what you're going to say.
Don't get on the phone and think, Oh, I'm just going to tell them what my situation is. It's going to make it better. They will guilt you. They will shame you. They will try everything they can. How much can you pay?
What about $50? Can you pay $50 by next week? Why can't you pay $50 by next week? Right? Just stay off the damn phone until you're ready. Have a plan first.
And with phones these days, like the new iPhone call screening function, I love that thing because it asks the person, What are you calling about? And then it shows you on your screen, you know, Bob's calling about something, and you can just go skip. Yeah, well, I liked it when I got the new update. I liked it for about a day. And then I had to say, I'm not going to name the law firm, but there's a law firm I was negotiating a deal with for a client, and I hate their phone system. I mean, I absolutely hate it.
If you call, you'll be on hold for 20 or 30 minutes. Nobody will ever pick up the phone, right? So you just, you know, they're not going to answer because their time is valuable, but yours is not. So then they have this feature, you know, Oh, push one and we'll call, you know, keep place in line, we'll call you back. Okay, no problem. You push one.
That actually works semi-okay because they will actually call you back, usually within 15 to 20 minutes. The problem for me is, of course, I can't make any other phone calls once I do that because I'll miss their call, right? And then we'll be doing that all day. Well, that kind of worked fine for a while because I deal with this law firm quite a bit, and they're nice and everything. It's just their system sucks. And so I got this new upgrade and had that, you know, screening thing.
Well, I learned while I was in the parking lot, actually, yesterday doing calls at the hospital, when their callback would come through and my screening thing would come on, it was disconnecting the callback because it was their machine calling my damn machine, and when I pushed it to answer, it would just hang up. And then I have to call back and start all over, get through the front. And so I spent two hours trying to get that law firm on the phone yesterday to the point I got so frustrated, I went, figured it out in the settings, and I shut that stupid feature off. But for regular consumers, it's a great feature. But if you're calling law firms with stupid phone systems, I just had to shut it off. I can't use it.
Sucks, man. That thing sucks. Anyway. All right, the topic of today's podcast was what forgiven debt means for your tax bill.
What a 1099-C Means for Your Tax Bill
So we're talking, this is the time of year mailboxes are starting to get those 1099-C forms for canceled debt. Shot to the heart, too late. Well, yes and no. So the 1099-C calculator, let me give you an example. Damon, I'm going to ask you four questions, and we're going to look at what the results were, okay? Uh-oh.
Yeah. Was this debt on a mortgage on your primary residence? Oh, I'm supposed to answer these? Mm-hmm. No. Okay.
Was this a farm debt? Nope. Now. How much debt was canceled? Just give me a number. Ten thousand.
All right. And in case you missed it, Steve's going through his tool. Yeah, on the side. That's because I'm a tool. Yeah. Tool made a tool.
All right, how much money you got in your checking or savings account? Two grand. Okay. You got any money in an investment account? Fifty K. Retirement account?
A hundred K. How much are your vehicles worth? Ten thousand. All right, so your total assets are $312,000. Awesome. Because the IRS counts retirement accounts and that other stuff, and so you're going to owe tax.
Not awesome. Not awesome. Awesome, not awesome. So you just can't assume that you get a 1099-C and you don't have to worry about it. The other thing is, again, we're not beating the bankruptcy drum just to push bankruptcy, because Damon and I don't make any money if you file bankruptcy. But if you do file bankruptcy, that's the end of it.
Any debt forgiven in bankruptcy is not taxable, period. Done. Steve, why are we stupid? We spend all this time talking about bankruptcy and we don't make money. We don't make any money. What?
You know, we're the only ones really talking about—why is that, I wonder? Yeah. Maybe because you don't make any money when they file bankruptcy, so don't tell them about it. Well, and the funny thing is, the bankruptcy attorneys make money, but we're not bankruptcy attorneys. So, I mean, we make money in other ways by helping people, but, you know, that's just not our model. I don't.
Well, you got ad revenue from the site and things like that. No, I don't. You don't have ad revenue anymore? No, there's no ads on the site. You stupid. I make zero money.
Off the website. Steve does it for the love of the game. I'm just trying to help people. Now, I have this life motto, one of them that I've always lived by, that if you do good things, good things happen. And that's why I do all of this. Oh, I can attest to that.
I'm not going to tell the story because we're running out of time, but when I first met Steve years and years ago, in the pitch that I made to him, and he thought about it, and no sane person in their right mind should have ever said yes to it because I couldn't offer him any money back then. And, I mean, I was nothing, but I basically was like, Hey, look, if you refer people to me, nobody's going to be complaining to you like, This person was pissed, whatever it was, right? And you're like, Huh, okay. Okay, so people will be happy and you don't pay me anything. Yeah, let's try it. Let's do that.
That was like my pitch. I can't pay you any money, but, you know, people will be thankful. Okay, let's do it. And I was like, and he's the only one that ever said yes to that. Like, Hey, look, I can't pay you money, but if you refer people to me, they'll be happy with you. And everybody else said, you know, go pound sand.
I'm making money on my website here. Right. And Steve's like, Oh, okay, yeah, I'll send people your way. Let's see how it goes. And that was what, 20 years ago? Something years ago, yeah.
Yeah. Anyway, back to cancellation of debt income. All right, so we talked about how to use the calculator. It's the easiest way to calculate your potential tax liability. The tricky part gets when— so if your liabilities exceed your assets, then you can not have to pay tax on it. You fill out a form and you don't have to pay tax on it.
The tricky part gets when your liabilities do not— Exceed your assets, and there's that gray area where part of it does. So you might owe tax on that. And the other thing I have is your typical CPA or, you know, tax person that does—not CPAs, but whoever the tax people, whatever we call them, you know, H&R Block and all that stuff. I've run into so many situations where they don't know about the Form 982 so you can get a waiver on the taxes that you owe. Oh, I get that a lot, and my response is, get a new tax person. Yeah.
Why do I know about that form? Yeah. So let me summarize it for everybody if they're kind of getting confused, because it can get a little tricky. Number one, if you go to getoutofdebt.org and just go to the top right corner, click the little magnifying glass, and just type in 1099-C, there's a ton of articles that Steve has written over the years about, you know, what to do if you get a 1099-C and how it works. But to answer the question of whether or not you may be taxed on forgiven debt, if you settle a debt, you know, if you owe 10 grand, they offer to accept $5,000 as a settlement, and then you get a 1099-C for the other five.
Free Tool — 1099-C Tax Calculator: Received a 1099-C for cancelled debt? The free 1099-C Tax Calculator runs the exact IRS insolvency math from Publication 4681 Worksheet 2 — and covers the partial insolvency case most people miss. Run the Calculator →
The Insolvency Test and Form 982
Everything revolves around what's called insolvency, whether or not you're insolvent. And in simple terms, all that means is if you add up all of your assets—this is why we have that calculator on the site where Steve was asking, you know, what do you have in your 401(k), what do you have in your savings account, what are your cars worth? So you add up all of your assets at the time that the debt was forgiven, and then you also add up all of your liabilities. If the number is positive, because liabilities would be a negative number, assets would be a positive number, and you add those together. If the number is positive, which means you have more assets than you have liabilities, liabilities would be the mortgage on your house, how much debt you actually have, student loan debt, credit cards, personal loans, balances remaining on your vehicle loans, any debts that you have. If that number is positive, that means you have a positive net worth, and you won't qualify for getting this waiver of having to pay taxes on that forgiven debt.
So that would mean if you don't qualify for the waiver and you get a 1099-C for $5,000, that would essentially act as if you made an extra $5,000 that year. So if you made $100,000— Yeah, so now that year you would have $105,000 worth of income, and you'd pay tax on $105,000 versus $100,000. So how much tax you'd pay would depend on your marginal tax rate. Now, if that number is negative, if your liabilities outweigh your assets, if you don't really have anything in a retirement account, if you don't own a house or you don't have much equity in it, and you've got $100,000 in debt, and you get a 1099, you add all that up and you're, you know, $90,000 negative net worth, that's when you do your taxes, you fill out that form 982, request a waiver, and you'll get that waiver. And the way it works is if you request it, you automatically get it. Now, you have to make sure you can justify your insolvency, and I'm not going to get into those details, but you have to maintain that information somewhere.
So if you ever get audited, like anything else— Seven years. Yeah, if you ever get audited, you need to be able to show, oh, this was what my net worth was. Five years ago, or whatever. This is why having records at the time and saving those records is important, because if you don't, even if you were legitimately insolvent, fast forward five years from now, you happen to get audited and they're asking for that information, you're not going to remember or be able to show what your house was worth five years ago or exactly what credit card balances you had. You won't have that information. So it's important that you save it if you're going to claim the insolvency rule.
So if your negative net worth, you might not have to pay taxes on that forgiven debt. So hopefully I simplified that. And if you're confused by it, you can reach out to me on the website and we can have a conversation about it. Yeah. There are a couple other situations with the 1099-C. One is you know that you had debt forgiven, but you didn't get the form.
That doesn't mean it wasn't reported to the IRS, right? You might not have gotten the form. The other one is you got a 1099-C on an old debt that was wrong, and trying to get that corrected can be like an act of God. It's almost just easier just to eat the tax. I'm not saying that's the right answer, but Steve's right on the act of God, maybe just shy. Yeah.
It's a mess. Sometimes the juice isn't worth the squeeze. No, not at all. So, 1099-C. All right, Damon, I'm just going to cut right to the very end because we're running out of time. We talked about how taxes are complicated, debt is complicated, and you put them together and people get scared and do nothing or they do the wrong silly thing.
That's the worst outcome. So those that are listening to us right now and today, now you understand the tax implications. You can plan accordingly. Yeah. And remember, we're not giving you enough information on this podcast to be able to navigate that. So go to the getoutofdebt.org website, click the magnifying glass and just write 1099-C, and there's more information that you could ever possibly want to know about specifically what to do if you get a 1099-C.
Yeah. That's so very true. Yeah. All right, Damon, I love our listeners. I love when they get in touch with you and they tell you, I'm a longtime listener, first-time caller. Yeah.
I feel like Loveline back in the day. That's right. But until next week, Damon, I will see you. Tom, like us in the morning. Peace.
Frequently Asked Questions
Is forgiven or settled debt taxable?
Generally yes. The IRS states that if your debt is canceled, forgiven, or discharged for less than the amount owed, the canceled amount is taxable. If you settle a $50,000 balance for $25,000, the forgiven $25,000 can be treated as income to you and reported on a Form 1099-C.
What is a 1099-C?
It is the information return a creditor files when it cancels debt, reporting the forgiven amount to you and to the IRS. They typically arrive early in the year for debt cancelled the year before. Two things people get wrong: creditors are generally only required to file one for cancelled debt of $600 or more, and — more importantly — the IRS says you must report cancelled debt as income even if no 1099-C ever reaches you, unless an exclusion applies. No form is not the same as no tax.
How does the insolvency exclusion work?
Cancelled debt is excluded from income to the extent you were insolvent immediately before the cancellation — the IRS's exact wording, and it matters when the cancellation itself changes your balance sheet. Add up everything you own — checking and savings, investments, retirement accounts, vehicles, home equity — and everything you owe, including your mortgage, cards, student loans and car loans. If your liabilities exceeded your assets on that date, you were insolvent by the difference, and the cancelled debt is excluded up to that amount.
Does my 401(k) count when calculating insolvency?
Yes. This is the detail that catches people. Retirement and investment accounts count as assets in the insolvency calculation even though you cannot spend them freely, and so do your vehicles. Someone who is struggling month to month can still be solvent on paper and owe real tax on forgiven debt.
What is Form 982 and do I need it?
Form 982 is how you report cancelled debt that qualifies for exclusion, and the IRS requires you to attach it to your tax return. Ask your tax preparer about it by name. If they have never filed one, find someone who has — the difference can be thousands of dollars on a form the IRS publishes for free.
Is the insolvency exclusion completely free?
Not quite. When you exclude cancelled debt from income you generally must make a corresponding reduction to certain tax attributes, such as loss carryforwards and the cost basis in your property. For most people in genuine financial distress it is still clearly worth doing, but it is part of the deal rather than a surprise to find later.
Is debt discharged in bankruptcy taxable?
No. Debt canceled in a Title 11 bankruptcy case is the first exclusion the IRS lists, so it is not cancellation-of-debt income at all. The same balance that can create a tax bill when settled creates none when discharged in bankruptcy — which is why comparing settlement and bankruptcy on after-tax cost gives a very different answer than comparing them on debt eliminated.
What if my 1099-C is wrong?
It happens, particularly on old debts, and getting a creditor to correct one can be extremely difficult. Sometimes the effort costs more than the tax. Just make that a deliberate decision with the numbers in front of you rather than one you drift into — and if the amount is large, it is worth pushing.
Does my state follow the federal rules on forgiven debt?
Not necessarily. Everything about the insolvency exclusion, Form 982 and the bankruptcy exclusion is FEDERAL treatment. States vary — some conform fully, some partly, some not at all — so it is possible to exclude cancelled debt on your federal return and still owe state income tax on the same amount. Check your own state's rules before assuming you are in the clear. This is general information, not tax advice — confirm your situation with a tax professional.
Is this tax advice?
No. I am not a tax professional and nothing here is tax advice. This is the plain-English version of how the rules work, with links to the IRS's own guidance, so you can ask better questions of someone qualified to answer them for your specific situation. Cancellation-of-debt rules turn on facts about your assets, liabilities and timing that only a professional reviewing your records can apply.
