Definition
Forgiven debt is a liability that is excused by a lender or debt collector.
Analysis
Forgiven debt may result from a number of situations in which a creditor excuses repayment for all or a portion of an outstanding debt. Situations may include:
Forgiven debt is viewed by the Internal Revenue Servce as taxable income. They view this cancellation of debt similar to a gift, which could increase your income tax liability. Additionally, the tax on forgiven debt is computed from your marginal (highest) tax rate.
Forgiven debt is automatically reported by creditors to the Internal Revenue Service anytime the forgiven amount is $600 or greater. This is reported to the IRS and to the debtor on Form 1099-C.
Exceptions
Forgiven debt from foreclosure is normally taxable income. However, an exception was granted through the Mortgage Forgiveness Debt Relief Act of 2007. This generally allows for homeowners to exclude forgiven mortgage debt (from 2007, 2008 and 2009) resulting from foreclosure of their primary residence.
Additional exceptions can include:
- debts discharged through bankruptcy
- insolvency
- some farm debts
- some non-recourse loans
