If Someone Pays Off Your Debt, Is That Income?
The tax consequences of having a debt paid off depend on the relationship between the parties and the reason for the payment. Learn how to classify it.
When a person’s debt is paid off by someone else, the tax implications are not straightforward. The tax treatment depends on the relationship between the individual and the payer, as well as the reason for the payment. This event could be classified as a non-taxable gift, a form of taxable income, or a distinct type of income governed by its own set of regulations.
When Debt Payment Is a Gift
If a friend or family member pays off your debt out of generosity with no expectation of being repaid, the payment is considered a gift. For the recipient, the value of the paid-off debt is not considered taxable income and does not need to be reported on an income tax return.
The tax considerations fall upon the person who made the payment—the giver. For 2025, an individual can give up to $19,000 to any other person without any tax consequences or filing requirements. This is known as the annual gift tax exclusion. A married couple can combine their exclusions and give up to $38,000 to one person.
If the debt payment exceeds this annual exclusion amount, the giver must file a gift tax return using Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. Filing this form does not necessarily mean the giver will owe taxes. The amount over the annual exclusion is applied against the giver’s lifetime gift and estate tax exemption, which for 2025 is $13.99 million per individual.
Debt Paid by an Employer
When an employer pays an employee’s personal debt, the payment is treated as taxable compensation. The amount paid by the employer must be included in the employee’s gross income and is subject to federal income tax, Social Security, and Medicare taxes.
A common example is an employer student loan repayment assistance program. Under these arrangements, an employer makes payments directly to an employee’s student loan servicer. The employer will include the total amount of the loan payments on the employee’s Form W-2, Wage and Tax Statement.
An exception exists under Section 127 of the Internal Revenue Code. Through 2025, employers can provide up to $5,250 per employee each year for student loan repayment on a tax-free basis. Any amount paid by the employer above this threshold must be included in the employee’s taxable income.
Canceled Debt from a Lender
A different situation arises when the original lender forgives or cancels a debt. When a debt is canceled or discharged for less than the full amount owed, the canceled portion is considered Cancellation of Debt (COD) income, which is taxable to the debtor.
Lenders who forgive $600 or more of debt are required to issue Form 1099-C, Cancellation of Debt, to both the debtor and the IRS. This form details the amount of debt that was canceled. Receiving a Form 1099-C is a strong indicator that the IRS has been notified of this income.
For nonbusiness debts, such as a canceled credit card balance, this income is reported on Schedule 1 of Form 1040 as “Other Income.” Even if you do not receive a Form 1099-C, you are still legally required to report any canceled debt as income.
Common Exclusions for Canceled Debt
Even if you receive a Form 1099-C, the canceled debt may not be taxable if you qualify for an exclusion recognized by the IRS. To claim an exclusion, you must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, with your tax return.
One of the most common exclusions is for debt discharged in a Title 11 bankruptcy case. If a debt is canceled as part of a bankruptcy proceeding, it is not considered taxable income. You must use Form 982 to notify the IRS that the debt was discharged in bankruptcy.
Another exclusion is insolvency. You are considered insolvent if your total liabilities are greater than the fair market value of your total assets immediately before the debt was canceled. You can exclude COD income up to the amount by which you are insolvent.
For example, if you have $50,000 in assets and $80,000 in liabilities, you are insolvent by $30,000. If a lender cancels a $40,000 debt, you can exclude $30,000 of that income, but the remaining $10,000 would be taxable.
A third exclusion applies to qualified principal residence indebtedness. This allows homeowners to exclude canceled mortgage debt on their main home. This exclusion, extended through 2025, applies to debt forgiven in a foreclosure, short sale, or loan modification. The maximum amount of forgiven debt that can be excluded is $750,000 for married couples filing jointly and $375,000 for those married filing separately.