This is because under current IRS regulations the amount that you saved by entering into a settlement agreement with a creditor or a debt collector is considered to be taxable income. If the amount you owed was reduced by $600 or more, you’re required to report that amount to the IRS.
Unfortunately, this may come as a surprise to many people who don’t realize that the money they didn’t receive from a debt settlement is taxable. That savings can be a tax liability and the amount you owe on the balance reduction is based on your tax bracket.
There are certain kinds of debt forgiveness that are exempt from federal taxes. You should consult with a tax professional to ensure that you are paying the taxes you’re required to by law and that you don’t run into any post-April 15th surprises from the government.
According to CNBC, the IRS expects to receive 6.5 million of the Form 1099-C, Cancellation of Debt document this tax season, so if you benefited from a debt settlement in 2012, be on the look out for this form in your mailbox.