When the debt is forgiven and it becomes obvious that it will not be paid back - that amount is classified as COD - cancellation of debt (COD) income - and it is income recognized because loans are cancelled.
In general, you must report any taxable amount of a canceled debt for which you are liable as ordinary income from the cancellation of debt, on Form 1040.
In general - that is taxable income and reported on form 1040 line 21.
HOWEVER under certain conditions - you might be able to exclude COD income from taxable income.
You MIGHT qualify for the insolvency exclusion.When you prepare your Insolvency Worksheet - you need to determine if you were insolvent.
The worksheet may be found on page 8 in this publication -
You list all your assets and all liabilities - on the day before the loan was forgiven - so include that loan into the worksheet.
This worksheet is not sent with your tax return - just keep it for your record.
Do not send any supporting documents and do not send that Insolvency Worksheet - to the IRS - just keep for your record.
That exclusion is claimed on form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness.
and that form 982 should be included into her tax return.- check the box 1(b) and list excluded amount on line 2.
Here is the form -
In most situations - you would not use part II - as it would be unlikely that any item would apply to your situation.. but we need to verify anyway.
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