Alliance One Receivables Management, Inc. - Brice Jernigan And Mike R. I paid them $5,837 in 10/05 and now the IRS is after me! Mendota Minnesota

I'm a single mother who was left with a 9 month old baby and no child support for two years due to the red tape with my ex and his new wife. I admit I struggled and ran up a debt but that was the ONLY way we survived. I made about $100 over the qualifying amount for public assistance and had no family who could help us with financial assistance so I had no choice, my baby needed formula and diapers and I needed to eat. That coupled with car repairs my balance grew to $12,972. I tried a low payment plan with Citibank/Sears for about a year, when that stopped the payments were just to much for me to handle - I either pay for the roof over our heads or the credit card bill.
Well... Alliance One found me and the calls were out of control! They called my job and home then harassed me to the point where I couldn't take it anymore. I talked to Brice Jernigan (866-619-0653) and Mike R (866-439-4874), both agreed I could pay 45% or $5,837 and my debt would be paid off. I scraped the money together saving and borrowing money from friends then I sent the check in Oct. 2005 to P.O. Box 21882, Eagan, MN 55121.
A couple days ago I received a notice from the IRS telling me I didn't report this "Cancellation of Debt" of $7,134 (the difference I didn't pay) in 2006 and I now owed an additional $1,731 of tax plus interest for this additional "income". I had no idea I was supposed to report this, I thought it was considered paid off! I've never heard of anyone else having to pay taxes on the difference before! Doesn't this mean that everyone has to pay tax on anything considered a cancellation of debt??? What about all the foreclosures? Is the IRS going to charge everyone tax on their canceled debts for both foreclosures and credit cards? Seems to me like the IRS is going to make a bundle of money taxing debts not paid if this is the norm for everyone.
I'm still a single mother and I can't afford an accountant or a lawyer. I'm actually unemployed and my only income is child support, the area we live in is one of the highest unemployment areas in the country - so any advice or explanations would be appreciated before I contact the IRS.

Marie
Erie, Michigan
U.S.A.