The cancellation of debt, meaning any debt you are personally responsible for, can be taxable to you. Around the office, we call this “phantom income” or “ghost income” because it is not actually money that you received, but the IRS taxes you like you did.
However, if you are not personally responsible for the debt, then the debt will not be taxable to you when it is forgiven or cancelled. The taxation of the cancelled debt only applies to the person who was relieved of the debt, meaning the person who was personally responsible for the debt.
If you have any cancelled or forgiven debt, you should receive a Form 1099-C from the creditor that forgave the debt. You will then need to report it as ordinary income for that year’s income tax return. Because it is ordinary income, it is taxed at your normal tax bracket.
But, there are some exceptions to the rule that the cancelled debt is taxable to you. The most commonly used exceptions are for student loans, bankruptcy, or insolvency. If you or someone you know is dealing with tax issues, we can be reached at Hoorfarlaw.com or 816-524-4949.