Income Defined

• Internal Revenue Code Section 61 defines gross income as "all income from whatever source derived." The definition is broad; according to the U.S. Supreme Court in its "Commissioner vs. Glenshaw Glass Co." opinion, Congress intended the definition to be broad and enacted the language pursuant to the full extent of Congress' taxation powers. According to the Supreme Court, income means "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion."
  
  

Debt Discharge

• A clear example of an accession to wealth is someone receiving her paycheck -- the amount and value of the money is not in dispute, and the taxpayer can deposit the money into her bank and use it immediately. Problems arise with what "Forbes" magazine refers to as "phantom income." This is a tax liability, but the taxpayer has no actual cash. Debt discharge, or cancellation of debt is taxable income -- Section 61 of the IRC explicitly lists it as an example of what constitutes gross income.
  
  

Form 1099-C

• Lenders must provide the taxpayer with IRS Form 1099-C for any debt discharge over $600 as of the date of publication. Sending the taxpayer a 1099-C helps ensure that the payer will report the debt discharge on his income. For example, if a taxpayer settles a $10,000 debt for $5,000, the lender must send the taxpayer a 1099-C for $5,000 -- the amount forgiven by the debt. In essence, it is as if the bank has given that taxpayer $5,000, since the payer no longer is obligated to repay that debt; this accession to wealth, albeit phantom in nature, constitutes income and must be reported.
  
  

Other Issues

• Certain exceptions apply to the debt discharge rules. For example, if the debt was private, such as one between two family members, the lender could describe the discharge as a gift rather than a cancellation -- the gift may go toward the lender's total gift tax exclusion, but the debtor would not need to report it on his income. Likewise, taxpayers do not need to report debt forgiven under a will or debt forgiven when the debtor is insolvent. Whether a COD is taxable income depends on individual circumstances; you should consult with an attorney for independent advice on your specific situation.