If student loans worth 82K and consisting of 51K principal and 15K interest and 16K fees are settled for 61K how much is reportable to the internal revenue service as income or gain?

Answer 1

Answer

I'm answering this presuming there is no difference in Student Debt to regular...and i can't see why there should be:

Any amount below the amount you owe, that includes all charges, is considered a cancellation of debt. COD is taxable income. However, presuming the debt was owed to an actual lender, they should/will/must provide you with a 1099 that shows how much income you received for the COD. If it was just completed (anytime in 2006) you probably won't get this until Jan of 2007.

I'm pasting a long discussion below that I made concerning charge offs and forgiveness of debt, originally concerning a tax question.

A charge off (or write off) is the accounting process where a business acknowledges a receivable (an asset) it believes is uncollectable effectively does not exist. It is taking the cost of not collecting that receivable as a charge against current earnings. Hence the companies net current earnings is lower than they would have been and subsequently, the amount of income taxes they pay is also lower. IMPORTANT: It does not mean the debt is forgiven, just that they can�t collect it, or some portion of it. (See below).

They had an increased expense, made less money, they pay less taxes. It�s fair to say given a choice they would have preferred to have made the less net income by increasing say, salaries, medical benefits, advertising, new machinery, etc. Than essentially giving away their assets/earnings to someone else.

Taking a $100 sale on credit, the company shows the $100 as income on its income statement when the sale is made and, as no cash was received, reflects it by establishing a $100 asset (due from customer) on its balance sheet. If the transaction is completed, as the customer pays the balance sheet cash account is increased by the $100, and the due from customer account is decreased � no income effect (as that was recognized with the original posting).

So, say a company sold $100 in year 1, reported the income (through the income statement) and paid taxes on it and establishes an asset for the receivable. Then in year 2 finds that customer isn�t going to pay, it will have a charge of -$100 in year 2 (reducing the balance sheet asset account, with offset to the income statement), effectively recovering the taxes it paid in year 1.

While this seems fair there are, not suprisingly, a number of accounting, especially IRS tax accounting rules, that complicate it and it is not unusual at all for a company to not receive a complete or timely benefit for all of it�s charge offs. The tax rules for when an asset can be charged off are stricter than accounting). And for there to really be any benefit, the company must actually be making enough money on a tax basis in all those years. It must have taxable income and a tax it would have had to pay. If it was already losing money, paying little or no tax, losing more doesn�t get it more! But also at the State level where, the taxable income need is even greater, but another tax is frequently encountered. If that $100 also had say $6 sales tax collected and paid over to the State, the state makes recovering that $6 that was in reality never collected, very difficult, near impossible. (Note that the $6 is normally NOT part of the company�s income or sales but a collection in trust for the State and paid over on behalf of the customer). I think you would be hard pressed to call the above a benefit! The one not paying (who still owes and will forever owe the money), actually receives all the benefit, by basically enriching themselves through a theft. (Walking out and agreeing to pay, then not doing so is really very similar to simply walking out with out paying).

However, there is another consideration: What happens if the debt (or some portion) is forgiven?

Lets start with a basic tax concept: If you receive something of value (remember we�re talking in business, so from someone other than family), you have received a taxable income. (The one giving it rightfully has an expense). For example, remember the Oprah Winfrey thing where the audience got cars�and then found out they owed taxes on the value of the cars. In fact, when Oprah stepped up to pay the tax for them, she had to actually pay more than the tax on the car, (called a gross up), as the money she gave them to pay the tax is also taxable.

Hand in hand with that, and the example above, if you get a loan, it is NOT taxable income. The money was exchanged for the equally valued promise to repay.

So taking the example above, if a buyer receives the $100 merchandise and gives $100 value for it, obviously nothing income taxable to the buyer. But in this case the buyer receives the $100 of value and say makes a deal in year 2 that if the $100 promise it gave is forgiven for a payment of $75 sent today (frequently offered with words like ��because it�s all I have and otherwise you ain�t getting nothing�.�), then the $25 is considered a cancellation of indebtedness. COD income is taxable to the recipient. It isn�t a loan/exchange of value anymore, it�s a gift of value, and value, as in Oprah is taxable. While no one likes to pay tax, it is the correct outcome. The advantage is the debtor doesn�t owe anything anymore�other than tax on the gift.

This COD is a very big issue in major corporation financial reorganizations. When these companies financially restructure (Chapter 11 Bankruptcy), and creditors, generally Bondholders, agree to take less than the bond was issued for�and we are talkin