Debt Forgiveness Gross Income: Understanding Wally's Situation

What is Wally's gross income from the debt forgiveness this year?

a. Wally paid off the loan with interest at year-end.
b. Pay More Incorporated forgave the loan and interest on December 31.

Wally's gross income from the debt forgiveness would include the loan principal of $33,000 and the imputed interest of $5,445, totaling $38,445.

When Wally used the funds as a down payment on a speedboat and repaid the $33,000 loan (including $495 of interest) at year-end, his total gross income from the debt forgiveness included the principal amount of the loan and the imputed interest. If Pay More Incorporated forgave the loan and interest on December 31, Wally would have to recognize as gross income the amount of the loan and any accrued interest forgiven by his employer.

Since Wally would have paid interest of $5,940 at the prevailing federal interest rate, but only paid $495 with the special interest rate given by Pay More, the difference of $5,445 ($5,940 - $495) represents the imputed interest which is considered income. Therefore, Wally's gross income from the forgiveness of the debt would be the principal amount of the loan, $33,000, plus the imputed interest of $5,445, totaling $38,445.