Mike is a college student who has big ideas but often fails to follow through on
ID: 2731404 • Letter: M
Question
Mike is a college student who has big ideas but often fails to follow through on those ideas. Mike borrowed $80,000 to pay for his tuition, books, and room and board. Mike is required to pay the money back to the bank, along with 6% interest, within 24 months of graduating. 2015 will be Mike’s 6th year as a full-time student at TSU and the bank is concerned about Mike’s lack of motivation to graduate and find a job so he can repay the loan. The bank meets with Mike and agrees that if he graduates in 2015, the bank will forgive $25,000 of the debt. Mike is so grateful for the bank working with him on the loan and promptly completes his general studies degree by the end of 2015. Over the next 24 months, Mike works hard and pays the bank $55,000. At that time, the bank confirms in writing that the $25,000 of debt is forgiven. At the time of the forgiveness, Mike had $10,000 of assets and no debts other than the $25,000 from the bank loan. How much income (if any) must Mike report as a result of this transaction? Be sure to explain your answer and provide citations where relevant.
Explanation / Answer
In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs. The canceled debt is not taxable, however, if the law specifically allows you to exclude it from gross income.
EXCEPTIONS to Cancellation of Debt Income, inter alia, includes:
Certain qualified student loans canceled under the loan provisions that the loans would be canceled if you work for a certain period of time in certain professions for a broad class of employers.
Assuming, MIke fulfills this criteria of exception, he is required to report and income in his tax return as a result of this transaction. However, the said income is not taxable.