Loan Co-Signers Should Not Be On The Hook With The IRS If The Debt Is Forgiven

We’ve written numerous stories over the years about parents who co-signed student loans for their children and then were stuck with the payments when their child passed away or could not find employment. Sometimes lenders will choose to forgive that debt, but even then some are making a mistake that could continue to hurt the co-signer at tax time.
The Newark Star-Ledger’s Bamboozled column has yet another sad story of parents burdened with their son’s student loans after he died too young. It’s definitely an article worth reading, especially for a section at the end that talks about mistakes being made by lenders after a loan is forgiven.
What happens is that lenders report canceled debts in excess of $600 to the IRS with a 1099-C form. The canceled debt is generally considered to be income for the borrower, so the borrower should be including the info from the 1099-C on his tax return. Depending on the amount of the loan, this can have a noticeable impact on how much the borrower owes or receives as a refund from the IRS.
Bamboozled reports that some lenders have been sending 1099-C forms to co-signers of forgiven loans, which means that the co-signers’ tax returns could now be negatively affected. However, it turns out that co-signors should not be receiving these forms in the first place.
“Solely for purposes of the reporting requirements of this section, a guarantor is not a debtor,” a certified public accountant tells Bamboozled, citing Treasury Regulation Sec. 1.6050P-1(7). “(It states) that co-signers are not considered debtors for reporting purposes and that reporting is not appropriate with respect to a guarantor, whether or not there has been a default and demand for payment made upon the guarantor.”
He says that co-signers who receive a 1099-C in error should contact the lender and ask it to issue a correct form.
In a recent Q&A series, the Consumer Financial Protection Bureau’s Student Loan Ombudsman told Consumerist that some student loans have conditions that allow co-signers to be released from any debt obligation, usually after the borrower makes a certain number of on-time payments. If you are a co-signer on a loan, you should ask the borrower to talk to their lender to see if such a release is possible.