Tax Implications for Settling Credit Card Debt (and How to Minimize What You Owe)

settling credit card debt tax implications

When settling credit card debt, tax implications may include treating the settled debt as taxable income. However, understanding the implications of paying taxes on a debt settlement, as well as understanding your own financial situation, can help you know what to expect, and in some cases, minimize what you owe when you settle your debt for less than you owe.

What happens when you settle credit card debt?

Debt settlement is a common form of debt relief. It typically occurs when a borrower is delinquent or in default on their debt. The borrower or a debt settlement professional negotiates with the creditor for an amount less than what is owed. Often, the settlement is fulfilled with a lump-sum payment or a payment plan. The creditor is more likely to negotiate a settlement if they feel as though it is the only way they will recoup any of the debt because you are delinquent. However, when you settle your credit card debt, you are completing your responsibility to the creditor, but the creditor is required to report your savings to the IRS.

What are the tax implications of settling credit card debt?

Because the creditor essentially forgives a portion of your credit card debt, the forgiven amount may be considered taxable income. The creditor will report the forgiven debt to the IRS. This may affect both your federal and state income taxes.

The 1099-C Form

If you settle credit card debt for more than $600 less than what you owe, the creditor is required to send you a 1099-C form at the end of the tax year. When you file your tax return, you will need to report the amount of the forgiven debt on this form. If you don’t receive this form from the creditor, they may have still reported the income to the IRS. But if you don’t report the income and the creditor has, you may receive a tax bill or be audited. Therefore, it’s important to know if you must report this income to avoid paying more in tax penalties.

Are there exceptions to these tax implications?

However, even though you are not repaying your debt in full, there are instances in which you may not face tax implications.

  • Insolvency: Insolvency is one of the most common exceptions to the tax implications of settling credit card debt. Insolvency means your total debts exceed your total assets. If you are deemed legally insolvent, you are excluded from being taxed on your forgiven debt, but only up to the amount you are insolvent. For example, say you have $100,000 in assets but $120,000 in debts. This means you are $20,000 insolvent. If your creditor has settled your credit card debt for $30,000 less than what you owed, you are excluded from being taxed on the $20,000, since you’re insolvent. However, you must pay taxes on the remaining $10,000 that was forgiven.
  • Bankruptcy: If your credit card debt is forgiven in bankruptcy, it cannot be taxed. This is true for any type of bankruptcy. And with bankruptcy, there is no limit on forgiven debt that will be excluded from being taxed.

How does the IRS know you’re exempt?

If either of these exemptions applies to you, you have to notify the IRS.

Form 982

You will fill out Form 982 to inform the IRS of your exemption. This form determines how much of the settled credit card debt is excluded from the tax implications. You will need to include the amount of the forgiven debt provided on the 1099-C form. The lender is required to send you a 1099-C form regardless of any possible exemptions you may have. If you neglect to fill out Form 982, it could raise suspicion from the IRS.

Is it worth it to settle credit card debt?

The idea of settling credit card debt for less than you owe may seem too good to be true. But paying taxes on the debt settlement may be the catch. However, understanding the exemptions can also help you determine whether it’s worth it for you. Many individuals who are in debt trouble are insolvent. Knowing the value of your debts compared to your assets can give you a clearer picture of whether you would owe taxes and how much you may be taxed on.

However, even if you are not exempt through insolvency or bankruptcy, settling credit card debt may be worth it for you, even with the tax implications. Most often, what you’ll pay in taxes on debt settlement will still save you money.

And settling credit card debt can have longer-term positive implications on your financial situation:

  • Lower debt-to-income ratio: Settling credit card debt lowers your total debt, which in turn helps your debt-to-income ratio. This can help you be more attractive to lenders and be more financially stable overall.
  • Cleaner credit report: While settled debt will be reported as “settled” rather than “paid in full,” this is still preferable to a delinquency or a default on your credit report. This is particularly important because payment history is the most significant factor in determining credit scores. This can actually boost your score.
  • Lower credit utilization: Settling your credit card debt will also lower your credit utilization. Your credit utilization is the amount you’ve borrowed versus the amount of credit you have available to you. Your credit utilization should ideally be below 30 percent. This is another significant contributing factor to your credit score.

Where can you turn for help?

Talking to a financial professional, such as a debt attorney, can help you understand the tax implications of settling credit card debt. A debt attorney can assist in navigating the complicated processes and criteria involved when settling debt and dealing with creditors. A debt help attorney can also guide you through the credit and debt management process, focusing on strategizing the best ways to resolve the debt, saving you money and time,  and helping relieve the stress and fears from having credit card debt.

The team at Tayne Law Group, P.C., is here for you on this journey. If you’re having debt trouble or have questions about paying taxes on a debt settlement, our team of experienced professionals can help. Call us for a free consultation at 866-890-7337 or fill out our short contact form and we’ll get in touch!

cartoon man with envelope

Money moves to help you stay on track

Sign up for monthly updates, articles, money advice, and timely topics to keep your finances on track.

Related Posts

what happens to a merchant cash advance if my business closes

What Happens to a Merchant Cash Advance If My Business Closes?

Whether you’re ready to pursue a new opportunity or your business simply isn’t performing, there may be a time you decide to close up business for good. And if that’s the case, you might be wondering: “What happens to a merchant cash advance if my business closes?” Closing a Business About half of small businesses […]

Read Now
white man looking at laptop thinking

What to Do if MCA Lender Files a UCC Lien Against You

If you’ve taken out a merchant cash advance (MCA), you may already have an MCA UCC lien on your business credit reports. While this is typical for MCAs and other forms of business financing, it could impact your ability to get credit in the future. This is especially the case if the information in the […]

Read Now
merchant cash advance collections

Merchant Cash Advance in Collections: What to Do

It’s common for small businesses in need of extra cash to seek out merchant cash advances (MCAs). Unlike a traditional loans, merchant cash advance companies provide a lump-sum payment in exchange for a certain percentage of your future sales or revenue. The approval and funding process is very quick — sometimes just one or two […]

Read Now

What is debt relief?

Debt relief is an umbrella term representing many solutions that may lower your debt. What kind of debt do you have?

black woman cartoon next to question mark

Need other debt help?

If you’re dealing with a lawsuit, judgment, frozen bank account, notice of wage garnishment, lien, or simply feel out of control of your debt–you are not alone. Give us a call or schedule a free consultation. We’ll help you understand what’s going on and find the best possible debt solution.

Why people choose Tayne Law

A debt relief law firm

Personalized Program

Every situation is unique. We’ll work with you to find a solution that resolves your debt and frees up your cash flow.


You make one low monthly payment and will never get an unexpected bill.

Experienced NY Debt Attorneys

We have more than 20+ years of experience providing clients with debt relief.

Confidential & Trusted

As a law firm, our attorneys follow strict client confidentiality. Our services are discrete and effective.

Work with Creditors

We work with all creditors, whether you’re dealing with a collections firm, a national bank, credit union, or another lender.

Request a Free Consultation

Your initial phone consultation is free and requires no committment!
A team member will respond within 1 business day.

tayne icon on cartoon letter in enveloper

Message Sent!

A Tayne Law team member will respond within
1 business day.