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Biz Brain: Couple has to pay income taxes on $20000 loan when it's forgiven ...

Q. Our son took out a student loan with a bank for $20,000. My wife and I co-signed the loan. He also took out other loans that did not require a co-signer. Our son passed away in February, and my wife was administrator of his estate, valued at approximately $1,100. She sent the required death certificates to all of his creditors and all of the loans were forgiven due to his death, but there was one difference for the loan we co-signed. That bank said they’d forgive it, but that as co-signers of the loan, we would have to consider the forgiven amount as ordinary income. This does not sound correct to us. We did not realize any income from the loan forgiveness, only the sorrow of the loss of our son. Is this correct? Can any "income" we realize be offset by funeral and other expenses?

— Dear old dad

A. Deepest condolences on the death of your son.

We’re afraid the news here isn’t good.

Because you and your wife co-signed your son’s student loan, you were personally responsible for payment to the extent his assets were insufficient, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.

"As a result of the bank forgiving the debt, you received a benefit in the form of additional funds being retained by you, which funds would have been used to pay the loan if not forgiven," she said.

The Internal Revenue Code specifically includes this type of discharge of indebtedness or cancellation of debt in gross income.

"There are exceptions, such as discharge which occurs in bankruptcy or if the debt is qualified principal residence indebtedness, however, the exceptions do not cover your circumstances," Romania said. "Although you will have to include the loan balance as income on your federal income tax return, you will not have to include it on your New Jersey income tax return, as New Jersey does not define gross income as including such a benefit.

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