
Quoting
Taxing Matters
The computation is done as of the day the debt is discharged. Let me give you a simple example. Joe owes his bank $20,000 on a personal loan. He settles that debt with the bank for $5,000. Thus $15,000 is discharged. Prior to the discharge, his total assets were $50,000 and his total debts (including the personal loan to the bank) were $60,000. Thus, immediately prior to the discharge, he was insolvent as his debts exceeded his assets by $10,000. Immediately after the discharge, his total assets are $45,000 and his total debts are now $40,000. So immediately after the debt, he is no longer insolvent. He is solvent by $5,000 and that $5,000 would then be taxable income as the result of the debt discharge. The remaining $10,000 of discharged debt is not included in his income, but he may have other tax adjustments to make to compensate for that.