Lone Tree, Colorado
The bank forgave $20,000.
The 1099-C says it is income.
The day before, you owed more than you owned.
That is the whole test — and here is the worksheet.
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When a lender cancels a debt — a credit card settlement, a repossessed car, a short sale, a charged-off loan — the law treats the amount you no longer have to pay as income, and the lender reports it on Form 1099-C. There is an exception for people who were insolvent when it happened: if your total debts were more than the fair market value of everything you owned immediately before the cancellation, the forgiven amount is excluded from income up to the amount of that shortfall. The IRS explains it in Publication 4681, which includes the worksheet reproduced below. Our page on cancellation of debt covers the 1099-C and the other exclusions; this page is about the insolvency test itself and the worksheet.
You are insolvent, for this purpose only, when your liabilities exceed the fair market value of your assets. The measurement is taken immediately before the debt was canceled — not at year end, not when the 1099-C arrived, and not after the cancellation improved your balance sheet. The debt that is about to be forgiven is itself one of the liabilities, which is why many people who settle debts turn out to be insolvent: the settlement happened because they could not pay.
It has nothing to do with bankruptcy. A person can be insolvent under this test while paying every bill on time, and a debt discharged in a bankruptcy case has its own, better exclusion. It is a snapshot, and only the snapshot: being insolvent in March and solvent in October means the March cancellation is excluded and an October one is not.
↑ Back to top| Liabilities (all of them) | Assets (all of them, at what they would sell for) |
|---|---|
| The debt being canceled; every mortgage and home-equity loan; car loans; credit cards; medical bills; student loans; back taxes; judgments; business debts you are personally liable for; past-due interest, property taxes, utilities and child care; margin debt. | Cash and bank balances; the home and any other real estate; vehicles; household goods, electronics, tools, jewelry, clothing; stocks, bonds, mutual funds; retirement accounts and pensions; education accounts; life insurance cash value; deposits; business and partnership interests; everything else. |
| Nonrecourse debt (a loan where the lender can only take the collateral, common for Colorado mortgages that have been foreclosed and for some car loans) counts only up to the value of the property securing it, plus the amount of it being canceled. | Assets that creditors cannot reach under state law — the homestead, the retirement plan, the tools of a trade — still count. The Tax Court held in Carlson (2001) that the exemption rules are irrelevant. |
| A debt you merely guaranteed counts only if it is more likely than not you will have to pay it (Merkel, 1999). | Fair market value, not what you paid and not the insurance value: the house at what it would bring, the car at Blue Book, the furniture at garage-sale prices. |
The IRS does not care that the figures are estimates, but it does care that they are documented and dated near the cancellation. Statements from the month of the 1099-C’s box 1 date are the right evidence.
↑ Back to topThe exclusion is capped at the amount by which you were insolvent. If debts exceeded assets by $8,000 and the lender forgave $20,000, you exclude $8,000 and report $12,000. If the shortfall was $25,000, you exclude all $20,000 and the extra $5,000 of insolvency does nothing. The exclusion is claimed on Form 982, filed with the return for the year of the 1099-C: check box 1b, enter the excluded amount on line 2, and complete Part II if there are attributes to reduce. There is no election and no deadline beyond the return itself, but a return filed without the 982 leaves the IRS matching the 1099-C to income you never reported, which is a CP2000 a year later.
↑ Back to topEnter balances and values as of the day before the debt was canceled. Use the box 1 date on the 1099-C. Nothing you type leaves your browser.
| Part I · Liabilities (debts) immediately before the cancellation | ||
|---|---|---|
| 1 | Credit card debt | |
| 2 | Mortgages on real property (first and second mortgages and home equity loans, on any residence, investment or business property) | |
| 3 | Car and other vehicle loans | |
| 4 | Medical bills owed | |
| 5 | Student loans | |
| 6 | Accrued or past-due mortgage interest | |
| 7 | Accrued or past-due real estate taxes | |
| 8 | Accrued or past-due utilities | |
| 9 | Accrued or past-due child care costs | |
| 10 | Federal or state income taxes remaining due (prior returns) | |
| 11 | Judgments | |
| 12 | Business debts (including those owed as a sole proprietor or partner) | |
| 13 | Margin debt on stocks and other debt secured by investment assets other than real property | |
| 14 | Other liabilities not included above | |
| 15 | Total liabilities immediately before the cancellation (lines 1–14) | $0 |
| Part II · Fair market value of assets immediately before the cancellation | ||
| 16 | Cash and bank account balances | |
| 17 | Homes, including the land (main home, any other home, investment or business real estate) | |
| 18 | Cars and other vehicles | |
| 19 | Computers | |
| 20 | Household goods and furnishings (appliances, electronics, furniture) | |
| 21 | Tools | |
| 22 | Jewelry | |
| 23 | Clothing | |
| 24 | Books | |
| 25 | Stocks and bonds | |
| 26 | Investments in coins, stamps, paintings or other collectibles | |
| 27 | Firearms, sports, photographic and other hobby equipment | |
| 28 | Interest in retirement accounts (IRAs, 401(k)s and other plans) | |
| 29 | Interest in a pension plan | |
| 30 | Interest in education accounts | |
| 31 | Cash value of life insurance | |
| 32 | Security deposits with landlords, utilities and others | |
| 33 | Interests in partnerships | |
| 34 | Value of investment in a business | |
| 35 | Other investments (annuity contracts, guaranteed investment contracts, mutual funds, commodity accounts, hedge funds, options) | |
| 36 | Other assets not included above | |
| 37 | Fair market value of total assets immediately before the cancellation (lines 16–36) | $0 |
| Part III · Insolvency | ||
| 38 | Amount of insolvency: line 15 minus line 37. Zero or less means not insolvent. | $0 |
Print the finished worksheet and keep it with the return and the statements behind each number. It is not filed with the return; Form 982 is.
↑ Back to topDana settles $31,000 of credit card debt for $9,000 and gets a 1099-C for $22,000. The day before: liabilities $31,000 of cards, $14,000 car loan, $6,000 medical — $51,000. Assets: $1,200 in the bank, the car at $11,000, household goods $4,000, an old 401(k) with $9,000 — $25,200. Insolvent by $25,800, which is more than the $22,000 forgiven. Form 982, box 1b, line 2: $22,000. Taxable income from the 1099-C: zero.
Same facts, but Dana also has $18,000 in a Roth IRA. Assets are now $43,200 and the shortfall is $7,800. She excludes $7,800 and reports $14,200 of other income on Schedule 1. The Roth did not have to be touched to count.
Pat’s lender charges off a $40,000 second mortgage after a modification. Pat owes $390,000 on the first and $40,000 on the second, $12,000 on a car and $5,000 on cards: $447,000. The house is worth $520,000; add $18,000 of cash and retirement money and $14,000 of cars and contents: $552,000. Not insolvent — the equity in the house exceeds the other debt. The $40,000 is income unless another exclusion applies, and since the home-mortgage exclusion ended with 2025, for a 2026 cancellation it usually does not. (Had the house been worth $400,000, Pat would have been insolvent by $15,000 and excluded that much.)
The exclusion isn’t forgiveness; it is deferral, collected later from your tax attributes if you have any. The excluded amount reduces, in this order and dollar for dollar (credits at one-third): any net operating loss, the general business credit, the minimum tax credit, capital loss carryovers, the basis of your property, passive loss carryovers, and foreign tax credits. The reductions happen as of January 1 of the following year, so the current year’s return gets the full benefit of the attributes first. A wage earner with a settled credit card and no carryovers reduces nothing. A landlord who excludes $30,000 reduces the basis of the rental by $30,000, which means less depreciation and more gain on sale — still a good trade, since the tax comes later and at capital gain rates. You may elect on Form 982 to reduce the basis of depreciable property first, which preserves an NOL.
↑ Back to topInsolvency shows up twice in a tax practice. The first is this page: it keeps a canceled debt from becoming a tax. The second is when a tax debt already exists and can’t be paid, and the same balance sheet — what you own and what you owe, now with monthly income and expenses added — decides what the IRS will accept. That is the collection information statement, Form 433-A or 433-F, and it is the gate to an installment agreement over the streamlined limits, to currently-not-collectible status, and to an offer in compromise. The IRS does not use the word insolvent there; it uses reasonable collection potential, but the arithmetic starts in the same place. The next pages, paying the IRS over time and the offer in compromise, pick up from here.
↑ Back to topColorado has no separate rule. What Form 982 excludes federally is excluded on the DR 0104, and what is reported as income is taxed at 4.40%. Colorado does not tax forgiven student loan balances that the federal government taxes (verify — C.R.S. §39-22-104(4)(z), discharges after 2025).
↑ Back to topYes, unless an exclusion applies. The amount the lender gave up is income under §61(a)(11). The insolvency exclusion is the one most people qualify for and never claim: if your debts exceeded your assets just before the settlement, the forgiven amount is excluded up to that shortfall, on Form 982.
Yes. For this test the IRS counts every asset at fair market value, including retirement accounts, the home, and property that state law protects from creditors. The Tax Court settled that in Carlson (2001). The flip side is that every debt counts too, including the one being forgiven.
You exclude $8,000 and report $12,000 as income. The exclusion is limited to the amount by which you were insolvent, measured the moment before the debt was canceled.
It can. In exchange for the exclusion you reduce tax attributes — net operating losses, credit carryovers, capital loss carryovers, and the basis of property — in that order, by the amount excluded. For most people with a settled credit card, there are no attributes to reduce and the exclusion is free. For someone with a rental or a business, the basis reduction matters and is reported on Form 982, Part II.
No. Insolvency is measured for the person who owed the debt. On a joint return, each spouse’s insolvency is computed separately with that spouse’s assets and liabilities, and jointly held assets and debts are split by ownership.
Statements dated as close as possible to the cancellation date: mortgage and loan balances, credit card statements, bank and retirement balances, a Zillow or appraisal for the house, Kelley Blue Book for the cars, and a reasonable list of household goods. The worksheet on this page is the one the IRS publishes in Publication 4681; keep it with the return. The IRS does not require it to be attached but will ask for it in an exam.
For the Tax Shop desk · forms, code sections, and the things that get missed
If a 1099-C arrives, don’t pay tax on it until the worksheet has been run. Bring the statements from the month of the cancellation and we will fill in the 38 lines, file Form 982 if the numbers support it, and reduce the attributes properly if you have any. If the problem is a tax debt you can’t pay, the same balance sheet is where that conversation starts.
Call 303-734-1040 or stop by the office in Lone Tree. We’ve been reading the footnotes for Douglas County and the Denver area since 1969.
Figures reflect the 2026 tax year as currently published and are rounded for readability. Items marked (verify) are to be confirmed against IRS or Colorado DOR sources before the figures freeze in December. Written October 26, 2026.