I have a client with a large hospital bill, of which some of the debt was forgiven. I know that debt forgiveness is generally income. However, the code states (sect 1391) "But if the debtor's payment of the liability would have given rise to a deduction, the debtor won't have income from the discharge."

Since medical expenses are an itemized deduction, can I correctly assume this should not be treated as income? I am looking for a confirmation or a 2nd opinion.

Thanks as always for the help!

“Since medical expenses are an itemized deduction, can I correctly assume this should not be treated as income?”---> Under other circumstances, he would potentially include a forgiveness of debt as income; debt that are forgiven outside of a bankrupcy or insolvency should be including in income. He will receive a 1099 from the foundation if he is to include it. If the hospital sends him and the IRS a form 1099C (cancellation of debt) then it would be concidered income to him. If they do not send the form to him, they STILL may consider the debt not paid in full. However I guess, since had he paid the debt, it would have resulted in a deduction to him on 1040 Schedule A as said above, the cancellation of debt is not considered income to him, to the amount that paying the liability would have resulted in a deduction. What I mean is that asssume that his agi is $100,000 and the forgiven medical expense is $10,000. To be deductible medical expense, he needs to pay at least $7,500; 7.5% *$100,000=$7,500. So, $10,000-$7,500=$2,500 is considered to be income.

Thanks for the response

I just realized...did you happen to mix up the numbers in your example? If $10,000 was forgiven, $7,500 would not have been a deduction because it was below the threshold. Therefore $7,500 would be treated as income and $2,500 would not because it would have been a deduction. That makes sense but I wanted to include the correct amount in income.

Thanks. Sorry to be picky.

“Therefore $7,500 would be treated as income and $2,500 would not because it would have been a deduction. That makes sense but I wanted to include the correct amount in income."---> Correct; I guess you are right.

Debt forgiveness is a fantastic thing for many people, as it means less than the whole of a debt has been compensated though the debt has been satisfied. However, it's considered taxable income and the mistake of a debt forgiveness tax break for foreclosures or short sales of homes is set to bite some taxpayers.