A cancellation of debt may occur if the creditor can't collect, or gives up on collecting, an amount you were obligated to pay.
Why It's Important
You may be thinking "Oh, this is awesome! Cancel all my debt, please and thank you!" But, not so fast. When a creditor forgives or discharges your debt for less than what you owe, it triggers a taxable event. The amount forgiven is then reported to the government as income from the creditor. You are required to report the canceled debt on your tax return for that year. You will receive a 1099-C from the creditor which gives you all the information you need for your taxes.
If the creditor sends you a 1099-C, they can no longer try to collect the debt. It is over with! If they still try to collect the debt after sending a 1099-C, do not put it on your taxes and give the creditor a call.
If the debt was secured by property and they take the property as a result of not paying the debt, the IRS looks at it as you sold the property to the creditor. The tax treatment of this scenario varies so get with a tax professional if you experience this situation.
There are exclusions to these IRS rules. For more information go here: https://www.irs.gov/taxtopics/tc431