Cancellation of Debt income (COD) arises when a creditor is owed a certain sum of money and accepts a reduced amount to settle the debt in full. The unpaid balance that is waived or forgiven represents cancellation of debt income, and this amount is usually reported to the Internal Revenue Service as taxable income. Typical examples of COD income include reduction of installment debt (such as credit card balances or car leases) and loan and home mortgage balances. Even if assets or collateral such as cars or homes are returned to the creditor in the hopes of satisfying the unpaid balance, the creditor may liquidate the assets at below market value leaving an unpaid portion of debt. This unpaid portion will then cause the recognition of COD income.

COD income must be reported on the debtor’s Federal income tax return and on most state income tax returns. The amount is included in calculating taxable income and income tax. As an example, if a debtor owed a credit card company $50,000 and reached a negotiated settlement for $5,000, the debtor would need to report the unpaid amount (COD income) of $45,000.  Depending upon other income, deductions and marital status, the COD income could result in an additional tax ranging between 10 and 45 percent of the $45,000. Thus, the actual cost of negotiating such a settlement could be much higher than the $5,000 payment made to the creditor, and funds should be set aside to pay the additional taxes.

There are limited exceptions to the realization of COD income. Debtors who negotiate a settlement of a mortgage on their qualified principal residence may be able to exclude up to $250,000 of COD income for single tax filers and $500,000 for married filers. If the debtor is insolvent, both before and after the negotiation, COD income is not realized. Finally, bankruptcy proceedings can usually result in a discharge of debt without realizing COD income. 

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If you are in the process of negotiating or restructuring any type of debt, it is advisable to consult your tax advisor before completing the process to ensure that all tax considerations and remedies are considered.


Richard M. Hoffman, CPA/CGMA is a member of the certified public accounting firm of Levine, Jacobs & Company, LLC.  He can be reached at