This is something that comes up during the short sale of a home or the compromise of a debt with a creditor. Basically, whenever a creditor is paid less than what is owed, and does not pursue the debtor for the balance, that balance is considered "forgiven."
Okay, but so what? So the creditor agreed to take less, and I am off the hook for the balance. Isn't that a good thing? Well yes, in a lot of ways, but you should be aware of a "gotcha" in that deal that most Americans don't know about: you have to pay taxes on the forgiven debt!
Yes, that's right. The IRS considers forgiven debt to be income and taxes it. For that reason, the creditor will send a 1099 to the IRS for the forgiven amount, and the feds will expect to see that income as a line item on your tax return. Learn More!