What is cancellation of debt income and how is it taxed?
When a lender forgives part or all of a debt, it results in so-called cancellation of debt (COD) income. As a general rule, COD income is taxable, and the lender is supposed to report the amount to you, and to the IRS, on Form 1099-C (Cancellation of Debt) for the year when the COD income occurs. Thankfully, there are some favorable exceptions to the general rule that COD income is taxable. Here are the taxpayer-friendly exceptions that are most likely to help you out. Bankruptcy Exception If the COD income occurs while the borrower is in Title 11 bankruptcy proceedings, the income is completely exempt from federal taxation. Title 11 encompasses bankruptcy filings under Chapter 7 (liquidations), Chapter 11 (reorganizations), and Chapter 13 (wage earner filings). Legislation passed in 2005 made it more difficult to file for Chapter 7 bankruptcy protection, thereby making it harder to be completely exonerated from unsecured debts such as credit-card balances. However, COD income can stil
