What does cancellation of debt mean?
According to financial attorney Leslie H. Tayne of Tayne Law Group, cancellation of debt is also known as debt forgiveness.
"It’s reducing what you owe to a lower or zero balance," she said.
However, COD doesn't happen automatically, and there are numerous steps that need to take place before creditors will wipe away a debt completely. There are also only a few strategies in which debt cancellation can even occur, Tayne said.
Debt cancellation can happen via debt settlement, where you negotiate a reduced balance with your creditor," she said. "It can also occur when debts get discharged in Chapter 7 bankruptcy."
Educational debt can also be canceled through various student loan relief and forgiveness programs.
Debt settlement
Theoretically, the funds in that account will be used to settle debts for less than you owe later on in the program. However, debt settlement comes with certain risks, including the risk that creditors won't negotiate. Also, stopping bill payments during the debt settlement process can cause considerable damage to your credit score.
» COMPARE: Best debt settlement companies
Chapter 7 bankruptcy
Liquidated assets are then sold off to help repay your debts. Many remaining debts can also be wiped away completely during bankruptcy, giving you a fresh start. Of course, Chapter 7 bankruptcy will harm your credit score dramatically and stay on your credit reports for 10 years.
Educational debt forgiveness
Public Service Loan Forgiveness (PSLF) is another plan for borrowers who work in eligible public service positions and repay their loans on an income-driven plan. These plans lead to forgiveness of remaining debt after 10 years provided all work and payment requirements are met.
Other educational debt forgiveness programs can be state-based or based on the industry someone works in. Teacher Loan Forgiveness for federal student loans is an example of a program geared to borrowers in a specific occupation. To see if you may qualify for a program, check with the office of Federal Student Aid and confirm it's applications are still open.
How to qualify for cancellation of debt
To qualify for cancellation of debt, you’ll need to meet specific requirements that vary depending on the type of debt you’re experiencing. At a high level, some of the most common requirements for cancellation of debt include:
- Student loan debt — Work full-time in a qualifying government or nonprofit role, make a certain number of monthly payments or work for a set amount of time in a specific industry
- Medical debt — Demonstrate financial hardship or fall below a percentage of the federal poverty line
- Credit card debt — Demonstrate financial hardship or show history of missed payments
- Bankruptcy — There isn’t a minimum amount of debt to qualify for Chapter 7 or Chapter 13 bankruptcy, although you’ll need to show proof that you cannot pay your debts. Afterwards, you'll complete a credit counseling course (Chapter7) or enroll in a debt management plan (Chapter 13)
Is cancellation of debt taxable?
According to Tayne, the IRS views any debt canceled exceeding $600 as taxable income. If you have your debt forgiven, you’ll need to fill out and submit another form when you file your taxes for the year the debt was forgiven or wiped away.
"Your creditor should provide tax form 1099-C to file with your tax return for the year the debt was forgiven," she said.
Tayne says the biggest consequence of this is the fact your tax bill could be higher than you expected.
"Knowing this, you should try to set aside the funds to cover this expense before you file your tax return," she said. "If you can’t pay the tax balance due, you should contact the IRS as soon as possible to work out alternate arrangements, like a payment plan."
There are notable exceptions when it comes to taxes on canceled debt, specifically regarding federal student loans. First off, debt forgiven through PSLF is not considered taxable income for IRS purposes. However, debts forgiven through income-driven repayment plans for federal student loans are normally considered taxable income. Former President Joe Biden's American Rescue Plan temporarily paused tax on debt forgiven through income-driven plans, but this exemption expired at the end of 2025. As of publishing, this still remains the case.
» MORE: How to file your taxes for free
How to remove canceled debt from your credit report
While cancellation of debt seems like it would positively impact your credit history, that isn't the case. Tayne says that your canceled debt doesn’t get erased from your credit history just because you no longer owe it.
"It will still appear on your credit report until it naturally falls off," she said, adding that the threshold where negative information falls off credit reports is seven years.
However, your report should reflect the account’s current status, such as “settled for less than the full amount” if a portion of the balance got forgiven via debt settlement.
» COMPARE: Best debt relief companies
FAQ
What is a 1099-C?
Form 1099-C is the form a company gives you when you have some or all of your debts canceled. This form is required when forgiven debt amounts are $600 or higher, although some exceptions apply for educational debt.
What happens when you get a cancellation of debt?
Having debt canceled can make it easier to get back on track with your finances, but you will likely owe taxes on forgiven amounts of $600 or more. If you do, you'll be given a Form 1099-C by the creditor that forgave the debt, and you'll submit this form when you file your taxes for the year the debt was forgiven.
When is cancellation of debt not taxable?
Canceled debt may not be taxable in some situations, including certain types of educational debt being forgiven. For example, federal student loans forgiven through PSLF are not considered taxable income.
Can I get an exclusion on my canceled debt?
There are some situations where you can apply for an exclusion on canceled debt, which lowers the taxable amount. A few examples include gifts, inheritances, Title 11 bankruptcy and cases of insolvency. If you qualify for an exclusion, you’ll need to file Form 982 with your tax return.
Bottom line
Cancellation of debt can help you get out of debt for less than you owe, but the process can be more difficult than people realize. For example, both debt settlement and bankruptcy come with a range of long-term consequences for your finances and your credit. Additionally, even if you do get debt wiped away, you'll likely owe income tax on forgiven amounts.
Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- U.S. Department of Education, “Public Service Loan Forgiveness.” Accessed Feb. 18, 2026.
- U.S. Department of Education, “Income-Driven Repayment Plans.” Accessed Feb. 18, 2026.
- Federal Trade Commission, "How To Get Out of Debt." Accessed Feb. 18, 2026.
- U.S. Department of Education, “Teacher Loan Forgiveness.” Accessed Feb. 18, 2026.
- U.S. Department of Education, “Complete the Public Service Loan Forgiveness (PSLF) Form With the PSLF Help Tool.” Accessed Feb. 18, 2026.
- Tax Foundation, "Inconsistent Tax Treatment of Student Loan Debt Forgiveness Creates Confusion." Accessed Feb. 18, 2026.
- Consumer Financial Protection Bureau, "How long does negative information remain on my credit report?" Accessed Feb. 18, 2026.
- IRS, "About Form 1099-C, Cancellation of Debt." Accessed Feb. 18, 2026.
- The White House, "Fact Sheet: President Donald J. Trump Restores Public Service Loan Forgiveness." Accessed Feb. 18, 2026.
- IRS, “Exceptions and Exclusions.” Accessed Feb. 18, 2026.
- IRS, “Topic no. 431, Canceled debt — Is it taxable or not?” Accessed Feb. 18, 2026.
