The Mitchell Law Firm, L.P.

Taxes on Discharged Debt

One question I often get is whether or not a debtor must pay taxes on debt that is discharged in bankruptcy.  If a debtor negotiates with his or her creditors for a reduction in the amount of the debt, then this would normally be the case.

The debtor would receive a 1099 at the end of the year for what is known as cancellation of indebtedness income (or discharge of indebtedness income).  In the bankruptcy context, this issue is addressed in Section  108 of the Internal Revenue Code.

And thankfully the answer is a confident NO.  Section 108(a)(1)(A) specifically provides that indebtedness discharged in a Title 11 case (which covers all chapter of a bankruptcy filing) is not included in gross income.