Millions of struggling Americans who reached settlements regarding their mortgages, credit cards or auto debts in 2009 may be getting surprised by tax bills from Uncle Sam.

Months after resolving their debts with lenders, strapped consumers are receiving 1099-C "cancellation of debt" tax notices in the mail because the Internal Revenue Service considers forgiven or canceled debt as income.

Creditors and debt collectors who agree to accept at least $600 less than the original balance are required by law to file 1099-C forms with the IRS and send debtors notices as well. Taxpayers must report that "income" on their federal income tax returns.

"This has been the law for some time, but it's under more scrutiny now due to the growing incidence of debt forgiveness in the past few years," said Ben Woolsey, director of marketing and consumer research at CreditCards.com in Austin, Texas.

Researchers working for the website found a growing number of credit card companies have been sending out cancellation of debt notices, Mr. Woolsey said. "The major banks in 2009 particularly reached out to a number of customers," he said. "They proactively offered to settle with customers they determined either couldn't pay in full or were headed for financial trouble, to recoup some of the loan balances."

Not many consumers are aware of the tax implications of settling to pay a lesser amount than they owe on loans. Some who don't know what the 1099-C forms are for may be ignoring the notices, said Mr. Woolsey. Those who are not filing the 1099-Cs with their federal tax returns could be at risk for IRS audits, penalties and fines.

"I haven't had that many clients in this situation this year," said Howard Davis, president of Davis, Davis & Associates, a Downtown accounting firm. "But I've had people be a little surprised in the past when they've gotten a tax bill for settled debt. They weren't too happy about it."

There are some caveats. The forgiven debt is not taxable if it is related to a mortgage on a person's primary residence. Credit card and other loan settlements also are exempt if the person can prove he or she was insolvent at the time the debt was settled.

According to the IRS, the number of 1099-C cancellation of debt forms filed by creditors and debt collectors nearly doubled between 2003 and 2008. The IRS received a little under 1 million forms in 2003 and nearly 2 million in 2008. The projected number for 2009 is 2.5 million.

Part of the spike may be due to rising mortgage foreclosures. But much of it is attributed to credit card debt.

Ted Lanzaro Jr., president of Lanzaro CPA in Shelton, Conn., said he developed a tax service around the debt settlement provision when he began getting an increasing number of calls from lawyers related to short sales, loan modifications and settlement of credit card debt.

"In a lot of cases in Connecticut, these are former Wall Street executives laid off during the recession," Mr. Lanzaro said. "They are not poor people. ... I've done debt cancellations for investors with as many as 30 properties."

That doesn't apply to everybody who gets a 1099-C, of course. "It's nice to be able to help people who really need the help," he said.

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