It is perfectly possible that the unpaid balance on the loan will be TAXABLE INCOME to you for the tax year of discharge. If so, then you will receive a 1099-C Forgiveness of Debt at tax time showing the amount of the unpaid balance that you *will* be paying taxes on. So if this will be a large amount, there are several things to may want to consider.
- Start paying taxes on it now as you can, to the IRS at http://www.irs.gov/directpay. Overall, if you send the IRS (and your state too, if your state taxes personal income) 20% of the forgiven amount, you'll be fine at tax filing time and won't incur any tax underpayment penalties.
- You can expect the forgiven amount to raise your AGI for the year. If that will be by a significant amount, that can very easily put your entire household income into the next higher tax bracket. So if the forgiven amount will be large, you can expect that possibility. Plan accordingly.
