Many states consider cancelled or forgiven debts as income. You’re liable to pay taxes on this income is like any other income. Why lender cancels your debt if you’re required to report the cancelled debts as income the lender will send you an IRS form 1099-C to you.
The circumstances where you are required to pay taxes on the forgiven debt may arise when a debtor cancels forgives for some reason such as:
The statute limitation prohibits the debt being collected from you and a court judgment has dictated this.
You have settled the debt with the lender of the debt collection agency for an amount less than the original debt.
The lender has discontinued collection activity after a certain period of time for some reason such as business policy.
You don’t have to report your forgiven debts as income and pay taxes on it and all circumstances. Situations under which your debt can be cancelled but you don’t have to report it as taxable income are:
When the debt gets discharged as part of a bankruptcy filing, unless the debt was incurred for business or investment purposes.
Student loans that are forgiven by an educational institution that’s tax exempt and you work for a certain number of years for a qualified employer. You need to see IRS publication 970, chapter 5 for further information.
The best thing to do is to consult a tax professional such as a chartered accountant or attorney to confirm your state’s loss about reporting cancelled debts as taxable income since your state’s tax law for cancelled debts may be different from that of federal tax law.