What is the Difference Between Discharge Debt and Canceled Debt?

If you owe a substantial amount of debt, there are a few ways you can get rid of that debt, and one is filing for personal bankruptcy. First, and perhaps most obviously, you can pay off the debt. Whether you pay it off all at once or over time will not change the fact that the debt has been paid off. Of course, if you repay it over a longer period of time, you could end up paying more money in the long run due to interest. However, in the end, the debt is still paid off. When you do not pay off a debt, there are generally two other ways to eradicate the debt, and it is important to understand that they are quite distinct from one another and have different consequences.

We want to tell you more about discharging debt through consumer bankruptcy, and how that differs from having your debt canceled.

What Happens When My Debt is Discharged through Bankruptcy?
If you file for Chapter 7 or Chapter 13 bankruptcy, the end result is typically a discharge of eligible debts. While that discharge occurs at different points in time, both types of consumer bankruptcy usually end with a bankruptcy discharge. In a Chapter 7 bankruptcy case, the debtor can have eligible debts discharged at the end of the bankruptcy case—typically within a few months. The timeline for a Chapter 13 bankruptcy case is much longer. The debtor will make monthly payments according to the terms of a repayment plan, which usually lasts three to five years. At the end of the process, remaining eligible debt is discharged.

What does it mean to say that debt is discharged? The U.S. Courts explains that a bankruptcy discharge “releases the debtor from personal liability for certain specified types of debts,” which means that “the debtor is no longer legally required to pay any debts that are discharged.” To be sure, the discharge “is a permanent order prohibiting the creditors of the debtor from taking any form of collection action on discharged debts.” In other words, the debtor no longer owes the debt.

Now, what is particularly important to know about discharged debt in a bankruptcy case is that the debtor does not owe taxes on the amount of debt that has been discharged. When you file for bankruptcy and have debts discharged through bankruptcy, you are not usually required to list that discharged debt as part of your taxable income. This is different from how canceled or forgiven debt is treated.

Handling Canceled or Forgiven Debt
When a debtor has debt canceled or forgiven, this means the creditor writes off the debt, and the debtor no longer owes the money. For all intents and purposes, this aspect of canceled or forgiven debt is similar to debt that has been discharged in a bankruptcy case. However, there is a major difference in terms of tax.

If you have a debt canceled or forgiven, you are required to report that canceled or forgiven debt as taxable income, and you must pay income taxes on that amount. If the debt is relatively small, the amount of tax you will need to pay is not likely to be significant. However, in situations in which debtors have substantial amounts of debt canceled or forgiven—tens of thousands of dollars of debt—the tax liability can become crippling.

Contact a Bankruptcy Lawyer in Oak Park
For many debtors, due to the tax liability associated with canceled or forgiven debt, personal bankruptcy may be a better option for getting a fresh start. If you have questions, an Oak Park bankruptcy lawyer can assist you. Contact the Emerson Law Firm to learn more.


See Related Blog Posts:
I Cannot Make My Chapter 13 Bankruptcy Payment: What Options Do I Have?
Chapter 13 Bankruptcy and the Coronavirus: What You Should Know

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