As you may know, the IRS and many states characterize forgiven debts as taxable ordinary income. Creditors will send you a 1099 representing the amount of debt forgiveness.
Fortunately, the Internal Revenue Code contains an insolvency exclusion to forgiveness of debt income. If you (the debtor) are balance sheet insolvent both before and after the cancellation of debt, the ordinary income from the canceled debt is excluded from taxable income to the extent of the insolvency.
IRS publication 4681 gives several examples about how the insolvency exception applies and if you read this publication you will see that the concepts can be somewhat confusing because you must consider your insolvency both prior to and after the forgiveness as well as the amount of the forgiveness.
Here are my recommendations:
Many of the high volume tax preparers who advertise on TV may not be knowledgeable about student loan debt forgiveness or the insolvency exception or about bankruptcy implications. Make sure to raise this issue and do not hesitate to get a second opinion.
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