How does credit card debt forgiveness impact your taxes?

With persistent inflation and soaring interest rates dogging consumers in recent years, Americans now face over $1 trillion in credit card debt. The average American now owes around $8,000 in credit card debt.

That’s not an amount most households can repay quickly, especially if you carry a balance and must pay substantial interest rates. According to the Federal Reserve, the average credit card interest rate has skyrocketed from 16.45% in 2021 to its current rate of 22.76%. Even worse, a recent Consumer Financial Protection Bureau (CFPB) report found that 15 credit cards from nine of the largest issuers charge cardholders annual percentage rates (APRs) over 30%.

Unable to pay higher prices for everyday expenses, many Americans rely on credit cards to make ends meet. 

Amid these circumstances, it shouldn’t be surprising that many cardholders struggle to keep up with their payments. To that end, 30-day delinquency rates hit 3.25% in the second quarter of 2024, rising for the 11th consecutive quarter.

If your credit card debt has reached a dangerous level, consider your options, including debt consolidation, a home equity loan and credit counseling. If you’ve already missed payments and you’re staring at bankruptcy or other more serious options, credit card debt forgiveness—or debt settlement—may make sense. These programs negotiate with your creditors on your behalf to lower your debt and help you tackle it better. Before proceeding, however, it’s essential to consider how credit card forgiveness could impact your taxes.

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How does credit card debt forgiveness impact your taxes?

Pursuing credit card forgiveness through a debt settlement service could help you reduce your debt by allowing you to pay only a portion of what you owe. Remember, however, that the IRS adds any forgiven debt to your income.

“There are limited exceptions, but most debt settlements are considered taxable,” says James Guarino, CPA and managing director at Baker Newman Noyes in Woburn, MA. “This means the portion of the debt forgiven is reported on your tax return as additional ordinary income, and it can be subject to federal income tax at rates ranging from 10% to 37% for 2024, depending on one’s tax bracket.”

The amount you could owe the IRS for credit card forgiveness depends on your tax bracket. The higher your tax bracket, the more you will pay for any forgiven debt. For example, if you get a $10,000 debt settlement, and your income places you in the 20% tax bracket, you would owe $2,000 in federal taxes on your forgiven debt.

If you’re considering tackling your credit card debt through a settlement, you’ll need to report it and prepare for the tax bill ahead of time. “You should be ready to report any debt that is forgiven during tax season,” says Alex Beene, a financial literacy instructor at the University of Tennessee at Martin. “This will normally come in the form of a 1099-C from the institution that has forgiven the debt. This is one of the biggest mistakes I’ve seen some make. They don’t prepare for this, and as a result, they find themselves with a larger tax bill and an inability to pay it.”

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Who should consider credit card forgiveness?

Debt settlement offers a potential option to reduce your credit card debt, which could ease the strain on your budget. But, like bankruptcy, this option should be taken seriously as it could negatively affect your credit score.

As Melissa A. Caro, CFP and founder of My Retirement Network in New York City, notes, “Debt settlement is a last resort after exploring alternatives like debt consolidation, credit counseling or negotiating directly with creditors. But if you have a significant amount of unsecured debt—such as credit cards—can’t meet minimum payments and would even be potentially facing bankruptcy, then settlement can have a less severe impact on your credit score and financial future than declaring bankruptcy. However, it will still damage your credit score and may not eliminate the entire debt.”

The bottom line

If you decide to pursue credit card forgiveness through a debt settlement, be prepared to pay the income taxes. “If you are facing an additional tax burden from debt settlement, the two most important factors are to document every piece of paperwork in your forgiveness process and meet with a tax advisor to assess what your payments will look like and how to best pay them back,” says Beene.

If you’re concerned your credit card debt might be unsurmountable, explore all of your options, including debt consolidation loans and 0% balance transfer credit cards. However, if you don’t correct the behaviors that led to the debt, you could end up with more debt, making the problem worse. It’s also wise to consider working with a credit counselor who can help you set up a plan to pay off your debt.