Taxes and Canceled Debt

[jaberle]

California

In 2008, my son's stepmother stole and used his credit card for a purchase for her personal business. When the statement arrived and he confronted her, she indicated she would repay that amount. After realizing she was not going to repay this debt, he contacted the local PD and filed a report. He eventually took her to small claims court and was awarded a judgement for $7500 plus court costs. Shortly after, his stepmother filed bankruptcy and included that debt as part of her charge off.

He has since moved back to CA from UT and over the next 2 years he has fought with Wells Fargo and the vendor that authorized the credit card charge. My son hired an attorney and after finally realizing that my son did not receive any monetary compensation from this transaction, both have decided to forgive the debt. This is what he wanted but he also had a stipulation that any negative reports to his credit ratings would be repaired by each.

He filed his 2010 taxes and assumed all was fine until last week when he received a notice from the IRS stating he owed taxes on the balance of the debt he did not pay. Is this a normal thing or is this something he should retain an attorney to handle? Any advice will be greatly appreciated.

Thank you.

[FlyingRon]

He needs to explain the situation to the IRS (the attorney almost certainly knows the right word). This isn't a taxable forgiveness as he was never technically liable for the debt (and didn't receive the money in any fashion that was cancelled). All the IRS knows is Wells Fargo sent them a 1099-C. They assume it is taxable whether it actually is or not.