Cancellation of student loan debt

[kkuch]

Hello all. Hope everyone has smooth few weeks to the semi-finish line this season.

I have a client who has a 43k 1099-C from being a co-signer on his ex-girlfriends student loan debt. She was "responsible" for the payments and everything associated with the loan. Unfortunately for him she got the loan forgiven and received the same 43k 1099-C and is paying tax on that amount (the total loan was 43k so they both received the same 1099 for the same amount). Does he also owe tax on the whole 43k? I had him fill out an insolvency worksheet and he's still owe tax on about 30k, but was hoping for some way out of this mess. Especially since she is covering the tax on her end for the WHOLE amount! Any guidance would be very much appreciated.

Thank you!

[rbynaker]

We're going to start in Pub 4681 on page 4:

https://www.irs.gov/pub/irs-pdf/p4681.pdf

"Persons who each receive a Form 1099-C showing the full amount of debt. If you and another person were jointly and severally liable for a canceled debt, each of you may get a Form 1099-C showing the entire amount of the canceled debt. However, you may not have to report that entire amount as income. The amount, if any, you must report depends on all the facts and circumstances, including:
State law,

• The amount of debt proceeds each person received,
• How much of any interest deduction from the debt was claimed by each person,
• How much of the basis of any co-owned property bought with the debt proceeds was allocated to each co-owner, and
• Whether the canceled debt qualifies for any of the exceptions or exclusions described in this publication."

But then it leaves you hanging with no further explanation or examples of what to report if not "that entire amount." That leaves us with a bunch of court cases which refer to the concept of "accretion in assets." That boils down to "who got the benefit of the loan proceeds?"

The state law considerations typically hinge on the legal distinctions between a co-signer and a guarantor. If your client was merely a guarantor then look to this IRS memo:

https://www.irs.gov/pub/irs-wd/02-0024.pdf

"Section 108(e)(2) provides that no COD income is realized if payment of the obligation would have given rise to a deduction. A guarantor generally has a claim against the original debtor in an amount equal to the amount of the guarantee that is paid. Assuming such a claim is uncollectible, it would give rise to a bad debt deduction or capital loss for the guarantor if the guarantee were paid. Therefore, cancellation of an obligation that arises pursuant to a guarantee appears to be subject to § 108(e)(2). If the notes under which the taxpayers became personally liable on the indebtedness would entitle them to a claim against the original entity under applicable local law, which would give rise to a bad debt deduction, it could be argued that there is no COD on cancellation of the notes because of § 108(e)(2)."

Practically speaking, I would include this as other income and then (if appropriate) back it out as a corresponding negative "other income" with a statement attached indicating that the full amount of the COD income was included on [ex-girlfriend]'s 1040 (including SSN if you have it) and the amount properly allocated to the taxpayer is $0 based on the amount of debt proceeds each person received.

I would also recommend your client get all of the documentation showing where the loan proceeds went and it wouldn't hurt to inquire about student loan interest deductions that may or may not have been taken on prior returns of both taxpayer and ex-girlfriend. Prepare the client to expect a nastigram from the IRS 2 years from now and they need to be prepared to respond to it quickly with a mountain of paperwork.

Rick

[kkuch]

Thank you for such a detailed response! I really appreciate it