Tabitha Brown
Cancellation of debt (COD) happens when a lender formally agrees to let a borrower off the hook for repaying all or part of what they owe, whether through direct negotiation, a debt relief program, or bankruptcy court.
At a Glance
- Creditors can forgive debt through negotiation, hardship programs, debt settlement companies, or bankruptcy.
- Canceled debt of $600 or more is usually reported to the IRS and the borrower on Form 1099-C.
- Many types of canceled debt count as taxable income, though the tax code carves out numerous exceptions.
- Debt cancellation, especially through bankruptcy, can hurt your credit score for years.
How Borrowers Actually Get Debt Canceled
Getting a creditor to cancel debt rarely happens on a whim. Lenders want their money, so they typically only agree to forgive a balance when a borrower is seriously behind on payments and offers to pay back some portion of what's owed. Some credit agreements even include built in provisions for cancellation under specific circumstances.
Many lenders also run hardship programs, often for a small fee, that kick in when a borrower loses a job or faces a serious illness. Federal programs add another avenue: certain federal student loans and government backed mortgages carry a higher likelihood of forgiveness under relief initiatives tied to those programs. In the mortgage world, some lenders will also negotiate a reduction in the loan's principal balance simply because that costs them less than pushing a home into foreclosure.
Working With Debt Settlement Companies
Borrowers who are drowning in unsecured debt sometimes turn to debt settlement companies, for profit firms that negotiate with creditors on a client's behalf. These firms are legitimate options for people struggling to make minimum payments, but the process can stretch on for years, and it pays to confirm you're dealing with a reputable operator before signing up.
Debt settlement typically works by having the borrower stop making minimum payments, which pressures the creditor into accepting a settlement. Meanwhile, the client usually pays into an escrow account each month, building toward a lump sum that eventually gets handed to the creditor. Nonprofit credit counselors, including those available through the National Foundation for Credit Counseling, can also help set up a more structured debt management plan with payments sized to fit a borrower's budget.
When Bankruptcy Becomes the Option
For some borrowers, bankruptcy is the most realistic path to canceling debt, or the only one left. Chapter 7 and Chapter 13 are the two forms individuals use most often. Chapter 7 liquidates a borrower's assets to pay creditors, at least partially, while Chapter 13 lets borrowers keep certain assets in exchange for following a court supervised repayment plan.
Bankruptcy is not a decision to make lightly. A Chapter 7 filing can sit on a credit report for up to 10 years, and a Chapter 13 filing can linger for up to seven.
How the IRS Treats Canceled Debt
Canceled debt is generally treated as taxable income by the IRS. If a financial institution, credit union, government agency, or similar entity forgives $600 or more, the borrower should expect to receive Form 1099-C documenting the amount.
| Not Considered COD Income | Considered COD Income But Excluded From Reporting |
|---|---|
| Amounts canceled as gifts, bequests, or inheritances | Canceled debt from a Title 11 bankruptcy case |
| Certain qualified student loans forgiven for employment in specific professions | Canceled debt to the extent the borrower is insolvent |
| Certain student loan discharges between January 1, 2021 and December 31, 2025 | Cancellation of qualified farm indebtedness |
| Discharge due to death or total and permanent disability of the student | Cancellation of qualified real property business indebtedness |
| Amounts forgiven under certain student loan repayment assistance programs | Cancellation of qualified principal residence indebtedness |
| Amounts that would have been deductible if a cash basis taxpayer had paid them | |
| A qualified purchase price reduction from a property seller to a buyer |
Form 1099-C shows up for a wide range of situations beyond straightforward debt settlement, including foreclosure, repossession, returning property to a lender, abandoning secured property, modifying a loan on a primary residence, resolving credit card balances, and forgiveness for student loan borrowers on income driven repayment plans.
What Debt Cancellation Costs Your Credit
Debt settlement offers commonly land between 15% and 25% of the balance owed, but the tradeoff is a hit to your credit score. Bankruptcy carries an even longer shadow, with entries that can remain on credit reports for years and weigh down a score the entire time. Anyone weighing debt cancellation against other options, like a structured repayment plan or straightforward negotiation, should factor in how long that credit damage might last before deciding which route fits their situation best.
Ralph Fernandez
Alyssa Young