The Tax Surprise Few Credit Cardholders Know About

A concept image of credit cards fanned out to pick one.

By Matt Schulz

The day you finally pay off the last of your credit card debt is nothing short of monumental. The darkest depths of your debt struggle are over. It's as if you've just received a raise –- which, for all intents and purposes, you have.

Sure, things might not be perfect. For example, maybe you had to settle your debts, reaching an agreement with your issuer to pay off less than what you fully owe and calling it even. Maybe your credit leaves something to be desired. Still, with the debt beast slain, you can't help but feel victorious. But for many, the story isn't over -– because there's an unpleasant surprise that will be coming their way from Uncle Sam.


The Internal Revenue Service considers forgiven or canceled debt to be income. That means if you settled your debt for at least $600 less than what you owed, you'll receive a tax bill in the form of a 1099-C cancellation of debt notice from the IRS.

Say you have $15,000 in credit card debt. You're stuck and can't pay it, so you make a deal with your credit card issuer and it agrees to let you pay just $8,000 of it. That's great, right? Well, yes, it is -– except that you'll end up paying taxes on that $7,000 that you didn't have to pay back. Now, of course, paying the tax on $7,000 is obviously preferable to paying the $7,000 itself. However, that doesn't mean receiving that tax bill is any less of a shock.

In a perfect world, creditors and debt collectors would always inform debtors about the issue, or everyone would have access to a tax attorney who helps them understand the implications of settling that debt. That's obviously not the case, though.

Also, some people simply throw the form away when they get it, thinking they don't need to worry about it since they've already settled with that creditor. It happens every year. Americans who thought their debt issues were behind them face the unfortunate reality of a tax bill that they didn't anticipate – and certainly didn't plan for.

What You Need to Do

Don't expect things to improve anytime soon either. The IRS projects that about 6 million debt cancellation forms will be filed for the 2014 tax year. That's up fivefold from 1 million in 2003 but far less than the 7 million the IRS projects for 2022. So if you receive one of these forms, what should you do? Follow these steps:

  • Don't throw it out or ignore it. That won't make the problem go away.

  • Make sure you really do have to pay. The good news is that not all debt cancellations or reductions are counted as income. Again, the amount forgiven needs to be at least $600 to spur a 1099-C form. There are other exceptions, such as debts canceled in bankruptcy, debts canceled during insolvency and debts canceled as a gift. You can learn more about these and other exceptions and exclusions on the IRS website.

  • If none of the exceptions or exclusions apply to you, report the total forgiven amount as "other income" when preparing your taxes. Or if you have someone else prepare your taxes, be sure to tell him or her and provide the 1099-C form with the rest of your tax documents. The amount should go on line 21 of your 1040 tax form.

As with any situation involving tax laws, you might want to consider consulting a tax attorney before you make any decisions. Tax attorneys aren't inexpensive, but having someone to help you navigate the ridiculously complex world of tax law can be priceless.