Debt Discharged in Bankruptcy is not taxable – Bredow Law PLC Photo by rawpixel on Unsplash

Generally, when you borrow money, you may deposit a check in your bank account.  If you use a credit card, you receive money, property or services.  In both cases, you receive something and own a debt to a creditor.   The Internal Revenue Service (IRS) does not consider the value of the money, property or services you receive to be taxable income, because you incurred a debt you have to repay.    But, if you no longer have to pay the debt, the IRS considers the canceled debt to be Cancellation of Debt Income.  Cancellation of a debt may occur if the creditor cannot collect the debt, or gives up on collecting the debt. It may occur when a creditor forgives a debt that you owe, or accepts a Debt Settlement Agreement that pays off the debt for an amount less than is owed.  Cancellation of Debt will also occur due to bankruptcy discharge.

The IRS considers the amount of debt that is canceled to be taxable income.  But, there are exceptions to the rule.

The IRS Does Not Consider a Cancellation of Debt by a discharge in Chapter 7, Chapter 11, or Chapter 13 bankruptcy to be taxable.   You do not have to report or pay income tax on debts discharged in bankruptcy.  

The IRS Does Not Consider Any Of The Following To Be Taxable Cancellation Of Debt Income either:

• Debt canceled in a Title 11 bankruptcy case. (Chapter 7, 11 or 13)
• Debt canceled during insolvency.
• Cancellation of qualified farm indebtedness
• Cancellation of qualified real property business indebtedness
• Cancellation of qualified principal residence indebtedness that is discharged subject to an arrangement that is entered into and evidenced in writing before January 1, 2018.
• Amounts canceled as gifts, bequests, devises, or inheritances.
• Certain qualified student loans canceled under a qualified loan forgiveness program.
• A qualified purchase price reduction given by the seller of property to the buyer.
• Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program

If your debt is canceled, your creditor may send you a Form 1099-C.pdf, Cancellation of Debt Form.  This form indicates that the amount of debt that the creditor is canceling.   If a debt collector attempts to collect a debt after you received a 1099–C form, or after you receive a discharge in bankruptcy, the creditor may not have canceled the debt and you may not have income from a canceled debt. Or, the debt collector may have canceled the debt but the collector attempting to collect a charged off debt.  This is unlawful debt collection activity and if this happens, you should contact Bredow Law PLC for a consultation.