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Settling a Debt May Increase Your Taxable Income In addition, the IRS considers the forgiven amount as income, which means you may need to pay taxes on it. That additional income might also push you into a higher tax bracket, resulting in a larger tax bill.

If you settle a debt with a lender or collection agency, you can expect to receive a 1099-C. Make sure you receive confirmation of the settlement payment and forgiveness. That way, you can match it up with the information on the tax form.

Minnesota offers a state-specific tax exemption (subtraction) for some loan forgiveness programs that are subject to federal income tax. The exemption covers loan forgiveness under four federal income-based repayment plans and the Minnesota Teacher Shortage Loan forgiveness program.

Can I Avoid Paying Taxes on a Debt Settlement? If you save less than $600 on a debt settlement, you won't have to pay taxes on it. If you're negotiating with a creditor and your savings are around the $600 mark, ask them to cancel $599 in debt. Then, you'll have the most amount canceled, without incurring a tax bill.

Fortunately, the IRS has tax exemptions for debt cancellation. You might not have to pay income taxes on the amount if one of the following situations apply: The debt is canceled as a gift, inheritance or bequest. Student loans that are canceled if you work for a certain time period for certain classes of employers.

Most canceled debt is taxable If you are able to get a settlement that's significantly less than your total debts owed, you will be taxed on any forgiven debt over $600. ?The creditor is required to file a 1099-C form with the IRS, which will detail the amount of your settled debt,? says Tayne.