he Insolvency Rule (IRS publication 908)
Most Debtors find that there is actually a big “loop hole” called the insolvency rule that allows them to NOT have to pay any taxes on the forgiven debt. According to the IRS, if you are “insolvent” at the time of the debt forgiveness, (which most consumers are if they are enrolled in a debt negotiation program) then you have no tax liability on the debt reduction up to the point that you are insolvent.
Let me put that in English for everyone. If your debts outweigh your assets then you are insolvent. So if you have a negative net worth then the IRS lets you slide and does not require you to pay taxes on the forgiven debt. As an example, if you where 100K upside down on your house, had 50K in credit card debt and only 40K in assets then you would be insolvent by 110K and you would not have to pay taxes on any of the settled credit card debt..
Most consumers find that if they are so far upside down financially that they have to look into a debt negotiation strategy, that they are also insolvent and therefore not liable for additional taxes on the amount of debt forgiven. As always though, check with a qualified Tax consultant about your specific situation, and ask if the Insolvency Rules would apply to you.