Question

Jim is a college student who has big ideas but often fails to follow through on those ideas.  Jim borrowed $85,000 to pay for his tuition, books, and room and board. Jim is required to pay the money back to the bank, along with 6% interest, within 24 months of graduating. 2017 will be Jim’s 6^th year as a full-time student at ASU and the bank is concerned about Jims’s lack of motivation to graduate and find a job so he can repay the loan. The bank meets with Jim and agrees that if he graduates in 2017, the bank will forgive $30,000 of the debt.  Jim is so grateful for the bank working with him on the loan and promptly completes his general studies degree by the end of 2017. Over the next 24 months, Jim works hard and pays the bank $55,000. At that time, the bank confirms in writing that the $30,000 of debt is forgiven. At the time of the forgiveness, Jim had $20,000 of assets and no debts other than the $30,000 from the bank loan.

How much income (if any) must Jim report as a result of this transaction? Be sure to explain your answer and provide citations where relevant.

Answer 1

Since the debt forgiven is not an income for Jim and only increases his networth, thus the increase in networth should not be taxed.

This is in line with the argument that when a person borrows money, his inflow is not taxed as it is presumed that the debt would be paid back. Similarly any debt which is returned back is also not deducted from income to compute the income tax liability. So an increase in networth because of debt forgiveness is not an income and should not be taxed.

Reference:

Kahn, D., & Kahn, J. (2015). Cancellation of Debt and Related Transactions.