Debt charge-offs and cancellation of debt—two terms that sound similar but have very different implications for your finances.

It's crucial to understand how they differ, your rights and responsibilities in each case, and the steps to take to protect your credit and finances.

Keep reading to learn how to handle your debt obligations in each situation.

What does it mean when a debt is charged off?

When you fall seriously behind on repaying a credit card or personal loan debt, the lender will eventually "charge it off" their books as a loss. This typically happens after six months without a payment.

Charge-off is an accounting term—the creditor writes the outstanding debt balance off as a loss, so it's no longer a receivable asset.

But make no mistake—you still legally owe the debt. The creditor can continue trying to collect.

The charge-off also gets reported to the credit bureaus. This severely damages your credit score since it shows you failed to repay a major debt.

Do you have to keep paying a charged-off debt?

Even after a charge-off, the creditor or a collection agency can come after you for payments. And the debt continues growing due to interest and fees.

You're still legally obligated to pay—the charge-off does not erase the debt. However, making payments can restart the statute of limitations clock if the debt is older.

If you can afford to, it may be wise to settle a charged-off debt—paying a lump sum that's less than the full balance owed. This can help avoid creditor lawsuits or further collection hassles.

Just be sure to get any settlement offer in writing before sending payment. And ask for an updated credit report showing the account as "paid in full" rather than "settled."

How does a charge-off affect you financially?

Aside from damaging your credit, charge-offs can lead to:

Potential income tax liability - If a lender later cancels $600 or more of the debt, you may receive a 1099-C form reporting canceled debt as taxable income.

Higher interest rates - With the charge-off lowering your scores, you'll pay higher rates for loans and credit cards.

Difficulty qualifying for credit - Lenders view charge-offs as a red flag, making approval tough. Rebuilding credit takes time.

Collection harassment - Expect calls and letters demanding payment. Be aware of your rights under consumer protection laws.

Lawsuits - Creditors can sue over older debts. Expect legal notices to be served if they obtain a court judgment.

Wage garnishment - If sued for an unpaid charge-off, a court can order your employer to garnish wages to repay debts.

The financial fallouts of charge-offs are severe. Act to eventually pay off the debt, settle, or consider bankruptcy if the debts are overwhelming.

How does cancellation of debt differ from a charge-off?

Contrary to popular belief, charge-off and debt cancellation are not the same.

With a cancellation:

  • The creditor stops all efforts to collect and erases the debt balance.
  • They will not sell it to collectors or sue you down the road.
  • The account gets updated as closed with a $0 balance owed.

But you may owe income tax on the canceled amount:

  • If it's $600 or more, expect a 1099-C form from the creditor reporting canceled debt as taxable income.
  • You must report the income on your tax return unless you meet a specific IRS exclusion.
  • Not reporting it can lead to penalties, interest, and audit troubles.

What does it mean if you get a 1099-C for canceled debt?

Receiving a 1099-C means a creditor has removed a debt obligation of $600 or more from their books. They no longer can pursue collection.

The amount is considered taxable income by the IRS under the theory it's income you previously didn't have to repay.

You face potential penalties and interest if you don't report the income on your tax return. Certain excluded debts don't count as taxable income, but most canceled consumer debts do.

When do creditors issue a 1099-C form?

The IRS requires lenders to issue 1099-C forms for eligible canceled debts. Common reasons for debt cancellation include:

  • Settling debt for less than you owe
  • Filing for bankruptcy and getting debts discharged
  • Proving uncollectible hardship that leads the lender to write off the balance
  • Expiration of the statute of limitations period for collecting the debt
  • Foreclosure of a home or repossession of property relieving that mortgage or loan obligation

The date and amount canceled will be listed on the 1099-C form mailed to you and reported to the IRS.

How do you handle a 1099-C cancellation of debt?

If you receive a 1099-C, don't ignore it. Work with a tax pro to determine if you meet any IRS exemptions allowing you to exclude the canceled debt as income.

For example, if the cancellation occurred due to bankruptcy or insolvency, the debt isn't considered taxable income. You must file IRS Form 982 to claim an exclusion.

If no exclusion applies, report the amount from the 1099-C as "other income" on your tax return. The cancellation of debt essentially generates phantom income requiring you to pay income tax on it.

The good news is the debt no longer hangs over your head. But the bad news is it can increase the tax you owe unless excluded under the tax code.


Getting a debt charged off or cancelled are two very different scenarios. A charge-off just writes the debt off a creditor's books but you still owe it. Debt cancellation actually eliminates what you owe completely.

Charge-offs trash your credit scores, while debt cancellation helps by erasing the negative information. But cancellation can create a tax issue if you get a 1099-C reporting $600 or more of canceled debt as income.

Know your rights and responsibilities whenever you receive charge-off or debt cancellation notices. And don't hesitate to work with professionals to protect your finances, credit, and tax situation.