Discharge

Discharge summary:

• Discharge means you are legally freed from the obligation to repay your debt.

• Discharge or partial discharge is a main goal of bankruptcy.

• You can have federal student loan debt discharged if you qualify for a loan forgiveness program. 

• It’s important to get the details of your discharged debt in writing. 

Discharge Definition and Meaning

Discharge is the cancellation of debt. When your debt is discharged, you are legally freed from the obligation to pay back your remaining balance. Your debt could be discharged as part of bankruptcy proceedings or as part of an agreement with your creditors. Discharge is also available for federal student loan borrowers who qualify through loan forgiveness programs. 

Types of Debt Discharge 

Debt discharge can take different forms. Here are some common reasons why your debt could be discharged:

• If you complete bankruptcy: During bankruptcy proceedings, a judge will discharge or forgive any remaining eligible debts after you fulfill the requirements of your plan. 

• If you qualify for student loan forgiveness: You can have federal student loan debt discharged after you make all of your required qualifying payments  

• If you enter into an agreement with your creditors: Creditors will sometimes agree to discharge or forgive debt as part of a debt settlement agreement or debt repayment plan that you negotiate. 

When your debt is discharged, you no longer need to worry about being asked to pay back the remaining balance that was due. 

Key Aspects of Debt Discharge

It's very important to get proof that your debt is discharged—especially if you enter into a voluntary agreement with your creditors. You should make sure to get the terms of this agreement in writing.

If your debt is discharged via bankruptcy, you'll have proof in the form of the bankruptcy order. Your student loan servicer should also provide you with a statement showing your debt has been discharged after you qualify for loan forgiveness. 

You should keep this proof to make sure you have evidence that you no longer have any payment obligations in case a creditor starts trying to collect the debt again.

Tax consequences of debt discharge

In some cases, you may have to pay income taxes on the amount of your debt that was forgiven. If you're insolvent (what you owe is worth more than what you own), you won’t be responsible for income taxes on the forgiven amounts.

You won’t be taxed on debt that is discharged in bankruptcy. You also won't be taxed on debt forgiven as part of Public Service Loan Forgiveness.

Debt forgiven as part of an agreement with your creditors would typically be treated as taxable income. Also, you may owe tax on debt forgiven after you complete an income-driven federal student loan payment plan.

You can find out if your debt discharge will be taxable so you can plan for this. Start by looking at the IRS insolvency worksheet. Here’s an example of how it could work:

In this example, you're insolvent by $162,000. 

$236,000 − $74,000 = $162,000

If your credit card issuer agrees to forgive $10,000 of your balance, you wouldn't owe federal income taxes on that forgiven debt.

This example is purely for illustration, everyone’s financial situation is unique, and we’re not tax advisors. Talk to a qualified tax professional about your situation.