Debt settlement is a popular alternative to filing bankruptcy. It avoids the public embarrassment associated with filing bankruptcy and entanglement with the court system. However, debt settlement can create tax problems if you receive tax form 1099-C: Cancellation of Debt.
When a debt is settled for less than the balance owed, the creditor frequently files Form 1099-C with the IRS and sends the debtor a copy, although many clients claim they never receive the notice. In most cases the settlement of a debt is not taxable, but the IRS will not know if it is taxable or not unless you file IRS Form 982 with your tax return.
Generally speaking, a debt settlement is not taxable if you are insolvent when the debt is forgiven (i.e., you have more debt than property).
The Internal Revenue Service has published a helpful video on this topic below: