Posted by James Financial Services Inc

What is Cancellation of Debt?

What is Cancellation of Debt?

There are times a distressed borrower will negotiate with a creditor for debt relief. These borrowers will either file for bankruptcy or go with a debt relief program that can reduce the borrower's entire debt. 

When debt is cancelled, one needs to pay taxes on the amount cancelled. This is because Uncle Sam believes that any cancelled debt is an income. With this, borrowers need to make plans for the tax on their savings via the debt cancellation. 

For cancelled debts above $600, the borrower will have to file Form 1099-C. The amount of form 1099C that the IRS got has increased steadily over the years. When debts are cancelled, it provides a great relief to borrowers. There are times when the government also offers debt relief to countries to boost their economy. 

Debt Cancellation Exceptions 

When considering debt cancellation, there are some exceptions. According to Uncle Sam, the following are not classified as cases of debt cancellation:

  • Debt cancelled due to inheritance or gifts.

  • Certain qualified student loans which meet some criteria

  • Some relief programs aimed at providing health services

  • Price reduction on the purchase of a property made available by the seller

  • A student loan forgiven when the student became disabled or dead

Here are exclusions that Uncle Sam classifies as debt cancellation; however, Uncle Sam’s exclusion allows for them not to be reported as debt income. 

  • Debt cancelled from bankruptcy case (Title 11)

  • Qualified farm indebtedness that got cancelled 

  • Indebtedness from the qualified principal residence that got cancelled

  • Indebtedness from eligible real property estate business that got cancelled

Cancellation of Debt Strategy

Here are some common means in which debts get cancelled

Negotiating with Creditors

It is a pretty challenging task trying to negotiate debt cancellation with creditors. Many creditors will not easily cancel debts since their primary source of income is the interest and fees from the credit. There are some creditors, however, that have a clause in their credit agreement to take care of cancelled debt. 

Also, there is a credit relief service from many creditors that borrowers can claim for an extra fee, which can be applied in some hardship conditions like a medical emergency or the loss of a job. Ensure you review and understand the terms of the credit when approaching a creditor, as it can help you know if your creditor will make it easy for you to qualify for debt cancellation. 

There are credit loans issued from the federal government that come with a high probability of debt cancellation. These are mortgage loans or student loans that qualify for debt forgiveness with the relief program sponsored by the government.

Debt Relief Programs 

There are settlement companies and debt relief available throughout the country to assist people with debt forgiveness. Make sure to contact a credit counselling organization (National Foundation for Credit Counselors is a good example) that can help select the best program that corresponds to your situation. 

Debt settlement firms are profit-oriented companies that stand in for borrowers and help them negotiate a favourable debt settlement with their creditor. Working with such companies comes with various pros and cons, and settling a debt can take up to a year. However, if you have been delinquent in payment of your debt for years, debt settlement might be a good option.

Debt settlement firms will check the entire credit profile and get in touch with the creditor for the debt forgiveness on behalf of the borrower. For a debt relief program to work, a borrower needs to quit the monthly payment of their credit bill to increase the chances of settlement from their creditor. 

Many companies might require a monthly payment made on escrow targeted at a lump sum amount that will be settled in the future.



There are cases in which the best option for a borrower in distress is bankruptcy. With bankruptcy, both the court and the attorney backs up the borrower. In bankruptcy, debt forgiveness is not classified as income; hence there is no tax liability as in other forgiveness programs. 

While bankruptcy will discharge tax debts, it is a pretty complicated process with long term effects. Make sure to understand the impacts by speaking with an accountant or lawyer before considering this path.



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