What Is a Charge-Off Debt and How Does It Affect You?

A charge-off debt signals a serious delinquency on an account. It is primarily an accounting designation used by creditors to classify a debt as unlikely to be collected. While a charge-off indicates a loss for the original lender, the underlying debt is not forgiven, and the consumer remains legally obligated to repay it. This process sets in motion consequences that can affect an individual’s financial standing and future borrowing capacity.

The Creditor’s Action

Creditors implement a charge-off as an internal accounting procedure when a debt becomes severely delinquent. For revolving credit accounts like credit cards, this action typically occurs after 180 days of non-payment, a guideline often mandated by regulatory bodies such as the Office of the Comptroller of the Currency (OCC) for banks. This declaration allows the creditor to remove the debt from their active assets, reflecting its unlikelihood of recovery on their financial statements. The charge-off effectively closes the account to future charges, marking it as a loss for the lender.

Despite being written off for accounting purposes, the debt itself is not erased or forgiven. The consumer’s legal obligation to repay the debt persists. This accounting adjustment primarily serves to align the creditor’s financial records with the reality of the debt’s status, rather than absolving the debtor of responsibility.

Impact on Your Credit

A charged-off account appears as a negative entry on a consumer’s credit report and significantly harms their credit score. This status indicates to potential lenders that the consumer has failed to meet a financial obligation, signaling a high risk of future default. Payment history is a major factor in credit scoring models, accounting for 35% of a FICO Score, and a charge-off reflects a sustained period of missed payments. The negative impact accumulates over months of delinquency, with initial missed payments causing significant score reductions even before the charge-off occurs.

A charge-off remains on a credit report for up to seven years from the date of the original delinquency. This reporting period is governed by the Fair Credit Reporting Act (FCRA). Even if the debt is later paid or settled, the charge-off entry will remain on the report, though its status may be updated to “paid charge-off.” The presence of a charge-off can severely limit access to new credit, loans, and impact applications for housing or employment, as it signals financial instability to creditors.

Debt Collection After Charge-Off

The original creditor may continue their own collection efforts, often through an internal collection department. Alternatively, they might engage third-party collection agencies to pursue the debt. These agencies operate on a contingency basis, earning a percentage of the amount they collect.

A common scenario after a charge-off is the sale of the debt to a debt buyer. These entities purchase charged-off debts for a small fraction of their original face value, sometimes for as little as four to eight cents on the dollar. Once a debt is sold, the debt buyer assumes ownership and gains the right to collect the full amount owed from the consumer. The consumer will then be contacted by the debt buyer, who will attempt to recover the debt through various means, including phone calls and letters.

Tax Implications

If a creditor charges off a debt and subsequently forgives or cancels a portion of it, they are required to issue Form 1099-C, Cancellation of Debt, to the debtor and the Internal Revenue Service (IRS). This canceled debt amount is considered taxable income by the IRS and must be reported on the debtor’s tax return. The IRS treats this as income because the debtor received an economic benefit by no longer having to repay the obligation.

There are specific exceptions where canceled debt may not be considered taxable income. For instance, if the debtor was insolvent, meaning their total liabilities exceeded the fair market value of their assets, they may be able to exclude some or all of the canceled amount from their taxable income. Debt discharged through bankruptcy proceedings is also not considered taxable income. To claim an exclusion, the taxpayer needs to file IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, with their tax return.