Taxable Income

• The Internal Revenue Service treats many types of canceled debt as taxable income. As such, you need to include it in your gross income on your tax return and will likely need to pay income tax on it, unless you can offset it with tax deductions and credits. The amount of money you need to include as income is usually equal to the amount of the debt that was canceled. For example, if your credit card balance was $9,000 and you settled by paying $5,000, your canceled debt was $4,000 and you will need to report this $4,000 as income.
  
  

Filing Taxes

• List the full amount of debt that was canceled on Line 21 of Form 1040. The canceled debt is the difference between the amount you owed and the amount you paid in the settlement. If the credit card company canceled more than $600 of debt, it will send you Form 1099-C showing the amount of canceled debt. You can use this form to fill out your tax return. If the credit card was a business card, you should include the canceled debt on Schedule C, which you file for your business.
  
  

Exclusions

• In a few cases, you can exclude the settled debt from your income. Credit card accounts that you settle through bankruptcy do not count as canceled debts on which you need to pay taxes. You also do not need to pay taxes on canceled debts for which you were insolvent before you settled. Insolvency is when the sum of your debts exceeds the sum of your assets. For example, if you had credit card debt for $15,000 and the sum of your assets was $7,000, you were insolvent by $8,000. Therefore, you would not have to pay taxes on the first $8,000 of canceled debt. In both of these cases, you would use Form 982 to claim the exclusion.
  
  

Considerations

• Before settling a credit card debt, consider whether you can afford to pay the income taxes on the canceled debt next year. Even if you are only in the 15 percent tax bracket, you will owe as much as $150 per $1,000 of canceled debt. Especially if you cancel the credit card debt through a settlement company that charges a fee, you could end up paying the full amount of the debt anyway between the settlement, the fee and the income taxes.