Settled Debt as Income & Financial Aid?

[marriedstudents]

My husband and I would truly appreciate any help that anyone can give us!

Before we married, my husband had a ton of debt from all sorts of things. I helped him begin settling his debts and getting on the right track. He's also been able to finally go to college and has begun this semester. He qualified for a lot of federal financial aid because of his low 2009 income. He earned around $15,000. This past year he made even less than that.

During Fall 2010 we managed to settle 3/4 of his debt. We're on the last 1/4 (almost there...) now. Half of the debt, maybe around $30,000 (!!!) was with Bank of America so when we settled they informed us that they had to report it and we would receive a 1099 C and we would have to report it as income to the IRS.

We understand this and are fine with it. It'll be tough, but we're budgeting accordingly.

Our question is with regard to federal financial aid, specifically a pell grant. He has no student loans. His community college is paid for almost 100% by the grant. They ask for adjusted and gross income when you fill out the FAFSA form. His debt "income" will be around 3x as much as his "actual" income, so will this put him out of the low income range for receiving his usual federal grant? They base the grant on an EFC (expected family contribution) and for this semester based on his income from the 2009 tax returns, and the cost of instate tuition it was all pretty much paid for. $4,000 + for the year. Will we still get the same amount? Will the government distinguish between his "actual' income and his "debt" income for determining our level of need?

We are completely fine with paying taxes on the settled debt and will definitely be reporting it as income...we are just beginning to worry now that he won't receive much financial aid even though he has made less money this year than ever before...(probably around $10,000)

Thank you!

 

[ecmst12]

When did you get married? I hope it was after he filed the FAFSA for last year. This year you will need to include YOUR income as well, so he may not qualify regardless.

 

[marriedstudents]

i don't have an income. i would have mentioned it if i did i promise =)
we will combined have around $10,000 (not including the debt income). all from him.

 

[ecmst12]

Wow...I assumed if he made that little you must be supporting him, how do you eat and pay rent?

Sorry I don't know the answer to your question though; if no one here does, the financial aid office at your school might be able to help you.

 

[davew128]

There isn't a tax question here although I wonder if you hadn't considered the exceptions for including the forgiven debt as income.

 

[marriedstudents]

isn't it a tax question? the FAFSA directly mirrors the individual income tax form as far as questions go. they ask for adjusted gross income, gross income etc, and you derive all of your answers from your income tax form. i figured there might be people who had dealt with this before...? when i've tried asking people who know more about FAFSA than about taxes they are always confused about how settled debt could possibly count as income, and then it just becomes this long confusing conversation. so i am definitely sorry if i've posted in the wrong forum, but i just figured this is where the most informed (with regard to our specific question) people would be. apologies again!

also to answer specific questions....
the debt doesn't meet any of the exceptions. it's standard credit card debt. we settled with the creditor and it has to count as income and we have to pay taxes on it.

as far as us hardly having any income between us...(heh)...yes things are tight! the only reason we were able to be together and live our lives is because of my wonderful parents. they've gifted us (and my cat!) food money for the year and this is what allows us to get by. since it falls below the allowable untaxed gift amount it works out for everyone. as much as we hate having to take from them, we are grateful for their generosity. and as a 21 year old who still needs help from their parents i guess i shouldn't feel too ashamed =)
[and i promise once i finish graduate school i will pay them back tenfold!]

thanks for your responses!

 

[davew128]

isn't it a tax question?

No its not.

the debt doesn't meet any of the exceptions. it's standard credit card debt. we settled with the creditor and it has to count as income and we have to pay taxes on it.

Insolvency**************

 

[marriedstudents]

davew, could you define what counts as a tax question? your opinion, of course.

i don't know what you gain by pointing out that i've posted in the wrong forum...except a feeling of power/superiority of course.

perhaps, for your liking, my question was not worded correctly. really, this question was about, i suppose, falling under the poverty line, which we do, according to my husband's actual income. when the government counts settled debt as income so that you will pay taxes on it, does that also change whether or not you fall under the poverty line? i'm wondering if on the 1099 C (or any other tax form) if the government, for the purposes of determining how poor you are, still distinguishes between your actual income (i.e. money you can live off of) and your debt that you couldn't pay income (i.e. money that counts as income but actually is a cost to you)?

i surely do apologize for my inability to correctly word questions. my verbosity and supposed obscurantism unfortunately seem to know no bounds!!

and yes my husband is/was insolvent, however, that has nothing to do with his ability to pay taxes on his settled debt. because, well, he can, and he will.

 

[LdiJ]

davew, could you define what counts as a tax question? your opinion, of course.

i don't know what you gain by pointing out that i've posted in the wrong forum...except a feeling of power/superiority of course.

perhaps, for your liking, my question was not worded correctly. really, this question was about, i suppose, falling under the poverty line, which we do, according to my husband's actual income. when the government counts settled debt as income so that you will pay taxes on it, does that also change whether or not you fall under the poverty line? i'm wondering if on the 1099 C (or any other tax form) if the government, for the purposes of determining how poor you are, still distinguishes between your actual income (i.e. money you can live off of) and your debt that you couldn't pay income (i.e. money that counts as income but actually is a cost to you)?

i surely do apologize for my inability to correctly word questions. my verbosity and supposed obscurantism unfortunately seem to know no bounds!!

and yes my husband is/was insolvent, however, that has nothing to do with his ability to pay taxes on his settled debt. because, well, he can, and he will.

I think that what Dave was trying to point out is that you do have tax question, you just maybe a different tax question than you think you have.

You may be able to exclude some or all of that cancelled debt from your income, under the insolvency exclusion. If you are able to exclude the debt from income, then that eliminates your financial aid problem.

Your total debt (before the debt was cancelled) minus your total assets, equals the amount you are insolvent, and that is the amount that can be excluded from income.

Example: You have two cars worth 1500.00 each and household goods worth 2000.00. You have no savings in the bank or any other assets. Your total assets are 5000.00.

Before the debt was cancelled, your debt to Bank of America was 30k. If that was your only debt, then 30k minus 5k is 25K, and therefore you are insolvent in the amount of 25k.

You settle with Bank of America for 10k, leaving 15k in cancelled debt. You can then exclude that full debt from your income using form 982 with your tax return.

 

[marriedstudents]

thank you LdiJ for your really helpful reply!!

i looked up about exclusions to settled debt as taxable income before and somehow completely missed the insolvency exclusion. i'm reading up on it and i definitely think this might be our answer. will definitely take a lot of time and paperwork to look up.

am i understanding it correctly? the moment of insolvency is immediately prior to when the debt settlement/forgiveness took place? so for each account that was settled we must calculate what his assets were at that specific time? his liabilities will include all of his debt from all his various accounts?

also, his debt was accumulated before we were married...but when it comes to determining his insolvency do we calculate my assets as well? we were married at the time he settled his debt, but the debt itself is his only and and i have no legal ties to it. he was insolvent, but i was not. i have no debt and i don't really have any assets either. i guess that means together we are still insolvent though? even though he is in debt and i am not it seems like one's spouses assets count towards determining one's own insolvency at a given point in time? i'm really confused about this part.


[as a post-script question...for my own curiosity...does this mean that since i am married to him that i am insolvent, too heh? he has more liabilities than assets and i guess since i'm neutral even though we were married that still makes him insolvent. but what if i had assets? would that mean that the insolvency would be calculated by using (my assets + his assets) and (his debt)?]

 

[davew128]

If you file jointly your assets and liabilities are measured jointly. Which is also why when you deleted the question automatically posed in your first post, it becomes more difficult to answer the question; WHAT IS THE NAME OF YOUR STATE?

 

[marriedstudents]

davew, i honestly have no idea what you are talking about. i didn't delete anything. i've edited my initial post for clarity/grammar at times, but that was before anyone replied?

[p.s.i think LdiJ did a great job at answering my crazy questions and was really helpful. as a result, i'm almost certain we will count as insolvent at the time of the debt settlement in question and that makes our worries over receiving financial aid a moot point]

 

[CreativeBlock]

davew, i honestly have no idea what you are talking about. i didn't delete anything.

Actually, you did. In the beginning of each initial thread-starting post is the question "What is your state (US law only)?" That is the question DaveW is referring to.

So. Please answer that question (which DaveW asked in all caps, thereby demonstrating it's importance): What is your STATE?

Tax laws, IIANM, vary by state: hence that information's importance.

 

[davew128]

The significance is regarding asset and liability allocations for filing status which is state specific.

 

[LdiJ]

The significance is regarding asset and liability allocations for filing status which is state specific.

It sounds like they are sufficiently insolvent even jointly. However, that is for federal taxes. Some states do not follow the federal rules for insolvency and they may have to pay state tax on the cancelled debt, but that won't matter for FASFA.