One of the last things anyone wants to hear when they are desperately trying to pay off credit card debts that have been eating them alive is that they have to pay a debt settlement tax. But sadly that can be true if you choose to negotiate with a creditor for a settlement on a debt on which you have fallen behind. The process usually works through a debt settlement company or attorney concerning a debt for which you have missed three payments or more. If your creditor thinks you may be considering bankruptcy, they may be willing to accept a lump sum payoff for considerably less than the outstanding balance. Once that total is agreed upon and you have paid that lump sum settlement, the amount that was "written off" is income, eligible for income tax, if it equaled $600 or more. However, if you remain insolvent even after your debt settlement, meaning you still owe more than you're worth, you may not be required to pay that tax after all. Clearly, you would need a tax lawyer or tax professional to help you determine the tax liability on this money, but if you've written off more than $600 in debt, a few taxes may be a small price to pay.