How do you get out of paying the IRS for a "charge off" by a lender or debtor?

Question

I have a relative in deep do do, he is disabled and on SSI and SSD. He tried to work but got laid off. He is limited in income. I can't help because I am medically disabled.
He financed the car through a Bank. Then the loan got sold to a finance company. He stopped paying. The finance company repoed the vehicle and claimed a loss on the loan, charging the vehicle off.
The IRS is saying the loan is considered "a debtors income" and he is being subjected to paying $2000 dollars to the IRS

Answer 1

Although Cancellation of Debt, or COD as it's also known, is taxable income to the debtor there is an exclusion if the taxpayer is insolvent at the time of the COD. You are considered insolvent if your debts exceed the value of your assets immediately prior to the COD. File Form 982 to establish the insolvency claim. He may need to file an amended return for the tax year in question and include the Form 982 but that should get the IRS off of his back.

There's another issue here that will keep him out of trouble with the IRS. Although the COD may be income, it is reduced by the basis for the car. In nearly all cases, that will reduce the "income" to a non-deductible loss. See IRS Pub 544 for more information.

Answer 2

I'd be real surprised if he's subject to paying $2000 to the IRS - is that really the taxes, or the amount of the chargeoff? If it's the chargeoff, the tax on it would be that times his bracket, very likely a few hundred dollars if that - could be nothing depending on his other income.

I realize that is a lot of money to someone in his situation. But that's the taxes due. Sorry.