Lansdowne, PA asked in Consumer Law and Tax Law for Virginia

Q: My loans were forgiven due to a medical hardship (disability). Is there any exception to making that income?

There were exceptions but I didn't fit any that I saw but I'm not a lawyer. It seems unfair to forgive the loans and then make it an incredible amount to tax. The same hardship should not make it income in some cases. I'm ready to have the original 77,710.00 active again. It's cheaper for my current income.

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1 Lawyer Answer
Russell J. Haynes
Russell J. Haynes
PREMIUM
Answered
  • Tax Law Lawyer
  • Burke, VA
  • Licensed in Virginia

A: Yes, Congress in its infinite wisdom, chose to treat the forgiveness of debt as income for tax purposes, despite the liquidity problem that comes with a taxpayer being so broke a bank won't chase them for money, but then hitting a broke person with a big income tax bill. But they do it anyway. The most common exception to the inclusion of "discharge of indebtedness income" is the insolvency exception found Internal Revenue Code Section 108(a)(1)(b). That exception states that you do not have to include the forgiven debt in income for tax purposes to the extent you were insolvent at the time the debt was forgiven. This requires an analysis of your income and liabilities as of the date the loan was forgiven, which takes place on a Form 982 attached to your income tax return. If your debts exceed your assets, you are insolvent. If your debts were at least $77,710 more than your assets on the date the loan was forgiven, then none of the forgiven debt needs to be included in income. You can get more information on cancellation of debt income by reading IRS Publication 4681. You should also have a CPA prepare your tax return for the year the debt was forgiven and provide them with all of the information necessary to complete the insolvency worksheet. If you cannot claim the insolvency exception, or it provides incomplete relief, you may be stuck with the tax bill. But there is a world of options after that for dealing with unpayable tax debts, for which you should consult knowledgeable tax counsel.

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