Can Credit Card Debt Be Forgiven? What to Know

Credit card debt can be a substantial burden. When facing overwhelming balances, understanding pathways to reduce or eliminate the obligation is important. Various mechanisms exist where a portion of credit card debt can be forgiven or discharged. While offering financial relief, such resolution often involves considerations that impact an individual’s financial standing.

Negotiating Debt Settlement

Debt settlement involves an agreement where a creditor accepts a lower amount than the total owed to satisfy a debt. This approach is considered when a borrower faces severe financial hardship, making it difficult to repay the full amount. Creditors may agree to a settlement to recover some of the outstanding balance, rather than risk a complete loss if the borrower defaults or files for bankruptcy.

The process can be initiated directly by the individual or through a debt settlement company. If using a company, individuals often stop making payments to creditors and deposit funds into an escrow account. Once sufficient funds accumulate, the company negotiates with creditors, aiming to settle for a reduced sum, sometimes as low as 30% to 50% of the balance. Obtaining a written agreement from the creditor outlining the terms is important before making any payment. This lump-sum payment then satisfies the debt, with the remaining balance forgiven.

Creditors are not obligated to accept a settlement proposal, especially if the debt is not yet delinquent. If a debt has become significantly past due or is in collections, creditors may be more receptive to negotiation. While debt settlement can provide relief by reducing the amount owed, it can take 2 to 3 years to complete, during which time late fees and additional interest may accrue.

Bankruptcy for Credit Card Debt

Bankruptcy offers a legal process through which credit card debt can be discharged, providing financial restructuring. The two common types of bankruptcy for consumers are Chapter 7 and Chapter 13. Each addresses credit card debt differently, offering distinct routes for relief.

Chapter 7 bankruptcy, also known as liquidation, can eliminate most unsecured debts, including credit card debt, within a few months. To qualify, individuals must pass a “means test,” which evaluates income, expenses, and household size against state median income levels. If income is below the state median, individuals are eligible; if above, further calculations determine if they have sufficient disposable income to repay creditors. A successful Chapter 7 discharge legally releases the individual from liability for most credit card debt, meaning creditors can no longer pursue payment.

Chapter 13 bankruptcy, or reorganization, involves a court-approved repayment plan that lasts three to five years. Under this plan, individuals make regular payments to a bankruptcy trustee, who distributes funds to creditors. While not immediately discharging debt like Chapter 7, Chapter 13 allows individuals with a steady income to repay a portion of their credit card debt over time. Any remaining unsecured credit card debt not paid through the plan is discharged upon successful completion of the repayment period. The bankruptcy court oversees the process, and a trustee is appointed.

Tax Consequences of Forgiven Debt

When credit card debt is forgiven or canceled, it can have tax implications. The Internal Revenue Service (IRS) considers canceled debt as taxable income. This is because the amount forgiven is seen as income the individual no longer has to repay.

Creditors are required to issue Form 1099-C to both the individual and the IRS if the amount of debt forgiven is $600 or more. This form reports the amount and date of cancellation. Individuals report this amount as ordinary income on their federal tax return.

However, exceptions to this rule mean the forgiven debt may not be taxable. One exception applies if the debt is discharged through bankruptcy; debt discharged in a bankruptcy case is not considered taxable income. Another exception is insolvency, which applies when an individual’s total liabilities exceed the fair market value of their total assets immediately before debt cancellation. If insolvent, individuals may exclude some or all of the canceled debt from their taxable income up to the amount of their insolvency. To claim these exclusions, individuals need to file IRS Form 982 with their tax return.

Credit Reporting After Debt Resolution

The resolution of credit card debt, whether through settlement or bankruptcy, is recorded on an individual’s credit report. This provides a factual record of how the debt was handled. The way these events appear and their duration can vary based on the method of resolution.

A debt account resolved through a settlement agreement is reported on a credit report with a status indicating it was “settled for less than the full amount.” This entry remains on the credit report for up to seven years. The seven-year period begins from the date of the first missed payment that led to the settlement, not from the date the settlement was finalized. This status signals to future lenders that the original terms of the credit agreement were not fulfilled.

For bankruptcy filings, the information is recorded on the credit report. A Chapter 7 bankruptcy remains on a credit report for up to 10 years from the filing date. A Chapter 13 bankruptcy is reported for seven years from the date of filing. These entries appear in the public records section of the credit report. While these entries are factual records of the debt’s resolution, their impact on credit scores tends to diminish over time.