What Is Debt Forgiveness?

Even the most frugal people sometimes have trouble paying their bills. Carrying a large debt load for a home mortgage or student loan is especially challenging in times of financial hardship. In these difficult times, it's good to know about some of the options for debt forgiveness and how to pursue them. It's also valuable to be aware of some of the potential risks of debt forgiveness, namely when it might add to your income tax liability and when it does not.

Basics

Debt forgiveness is the process in which a creditor or a third party either forgives or pays down an individual's debt. Debt forgiveness programs are usually intended to help those in financial hardship by relieving them of some of their debt burdens. While many debt forgiveness programs are administered by government agencies, creditors such as home lenders and credit card companies also play a large role in forgiving debt. It's important to remember that, in some cases, forgiven debt is considered income for taxation purposes and can increase an household's tax liability.

Mortgage Forgiveness

In the wake of the 2008-2009 financial crisis, the government and major home lenders initiated debt forgiveness programs to help prevent foreclosures and assist homeowners in need. Programs like Making Home Affordable might be able to forgive some of the principal on home loans. In addition to these programs, the federal government helps lighten the burden by making debt forgiveness for mortgages tax-free. Under this tax provision, homeowners can receive up to $2 million in debt forgiveness without being subject to increased income tax liability.

Credit Card Debt Forgiveness

Credit card issuers also sometimes offer debt forgiveness to struggling credit cardholders. To pursue these options, a cardholder usually works with her credit card company or a credit counselor. Credit card debt forgiveness might involve the discharge of finance charges, interest or late payment fees as well as principal, depending on the policies of the lender. Unlike mortgage debt forgiveness, credit card debt forgiveness is usually taxable and must be reported to the IRS as income. Creditors will generally provide their customers with IRS Form 1099-C, which details taxable debt-forgiveness income.

Student Loan Forgiveness

Another major focus of debt forgiveness available from the government is student loan debt. Student loan debt forgiveness programs are usually intended to encourage public service such as volunteer work, military service or government employment. For example, AmeriCorps and the Peace Corps help pay down student loans in exchange for participation in volunteer service in either disadvantaged American communities or abroad. The government also forgives debt for teachers who receive federal student loans and work for up to five years in low-income community schools. Debt forgiveness on federal student loans is not considered taxable income by the IRS.