What is a potential tax consequence of debt settlement?

When debt is settled for less than the full amount owed, the amount of debt forgiven can be considered income by the IRS. This means that the forgiven debt may be subject to taxation, which is why it is classified as a taxable event.

For example, if a borrower owes $10,000 to a creditor and settles the debt for $6,000, the $4,000 that is forgiven is treated as income. Consequently, this amount must be reported on the taxpayer's income tax return, potentially increasing their tax liability for that year.

Understanding this tax implication is crucial for individuals considering debt settlement, as it can significantly affect their financial standing and tax responsibilities in the year the debt is forgiven.