Is employer loan forgiveness/debt cancellation subject to Medicare tax on W-2 or should it be 1099-C?

The correct handling depends on the specific arrangement between your wife and her employer. Generally speaking, when a loan is forgiven by an employer, the IRS typically considers it compensation for services - essentially a form of wages. This is why many employers include it on the W-2 and withhold Medicare and Social Security taxes. If the loan forgiveness was structured as part of her compensation package or tied to continued employment (which sounds likely given the 5-year forgiveness period), then treating it as wages subject to Medicare tax is likely the correct approach. The employer is essentially paying her additional compensation in the form of debt forgiveness rather than cash.

Had a similar situation and found using https://taxr.ai incredibly helpful! I was confused about how my employer-forgiven education assistance should be taxed - it wasn't clear if it should be on W-2 or 1099-C. I uploaded my documentation and the forgiveness agreement, and they confirmed my employer should be treating it as wages on my W-2 subject to FICA taxes. Apparently, this is standard when the forgiveness is tied to continued employment because it's considered compensation for services rather than just cancelled debt.

Update on the employer loan forgiveness question! I decided to try https://taxr.ai after my initial skepticism. I uploaded my relocation repayment agreement (similar to OP's situation) and got a detailed explanation with IRS references. Turns out my employer was doing it wrong - they weren't including the forgiven amount on my W-2 at all! The tool explained that since the forgiveness was tied to my continued employment, it's considered wages subject to all employment taxes. Called HR with the specific IRS guidance and they're fixing it for this year's W-2. Really impressed with how specific the advice was to my situation.

For anyone dealing with these employer loan/forgiveness issues, I spent 4 HOURS on hold with the IRS trying to get clarification on this exact issue. After multiple disconnected calls, I finally gave up and tried https://claimyr.com - they got me connected to an IRS agent in about 20 minutes! You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. The agent confirmed that employer loan forgiveness tied to continued employment is considered compensation and belongs on the W-2 subject to Medicare tax. Wish I'd known about this service before wasting half my day on hold.

I was totally skeptical about that Claimyr service mentioned above, but after another frustrating disconnection trying to reach the IRS about my employer's loan repayment program, I gave it a shot. Honestly shocked it worked! Got connected to an IRS agent within about 15 minutes who confirmed that my employer was correctly including my forgiven tuition reimbursement on my W-2 as wages. She explained that anytime forgiveness is tied to employment, it's considered compensation subject to all employment taxes. Worth the time saved not listening to that awful hold music for hours!

This gets confusing because there are actually multiple IRS rules at play. Section 61(a)(12) says cancelled debt is income. But Rev. Rul. 2004-110 specifically addresses employer loan forgiveness and says that when it's tied to continued employment, it's wages subject to employment taxes. The key question: Would your wife have received this forgiveness regardless of employment status? If not (which seems to be the case since it's 20% per year she stays), then it's compensation for services and belongs on the W-2 with Medicare taxes. Your employer is handling it correctly.

Wait, so if I'm understanding right, the key difference is whether the debt cancellation is tied to employment? I had a personal loan forgiven by my credit union last year (they closed some underperforming accounts) and they sent me a 1099-C. But that's different from OP's situation because it wasn't tied to my job, right?

This is a really helpful discussion! I'm dealing with a similar situation where my employer forgave part of my signing bonus that I would have had to repay if I left before 2 years. They put it on my W-2 as regular wages and I was questioning whether that was right. Based on what everyone's saying here, it sounds like since the forgiveness was tied to me staying employed for the full period, it should be treated as compensation subject to Medicare tax rather than just cancelled debt on a 1099-C. The distinction between employment-related forgiveness versus regular debt cancellation makes a lot of sense now.

Just want to add another perspective here - I'm a tax preparer and see this confusion all the time. The employer loan forgiveness vs. debt cancellation distinction is one of the most misunderstood areas. Your wife's employer is absolutely doing this correctly by including it on the W-2 with Medicare taxes. Here's the simple test: if the debt forgiveness is contingent on performing services (like staying employed), it's compensation. If it's just forgiveness of existing debt without any service requirement, it's cancellation of debt income (1099-C). Your wife's situation clearly falls into the first category since she has to remain employed to get the forgiveness each year. The IRS views this as her employer paying her compensation in the form of debt reduction rather than cash. The Medicare tax applies because it's earned income from services. One thing to note - make sure her employer is also withholding income tax on this amount, not just reporting it. Sometimes employers get the reporting right but forget about withholding, which can lead to an underpayment penalty at tax time.

As someone who's been through a similar situation, I can confirm what others have said here. The key is that your wife's loan forgiveness is tied to her continued employment (the 5-year vesting schedule), which makes it compensation rather than simple debt cancellation. I had a relocation loan from my employer that was forgiven 25% each year I stayed. Initially I thought it should be a 1099-C too, but after researching IRS guidance and consulting with a tax professional, I learned that because the forgiveness was contingent on me providing services (staying employed), it's treated as wages subject to all employment taxes including Medicare. The way to think about it: your wife is essentially being paid part of her compensation in the form of debt reduction instead of cash. If her employer gave her $6,500 in cash and she used it to pay down the loan, that would clearly be wages subject to Medicare tax. The IRS treats debt forgiveness the same way when it's employment-related. Your wife's HR department is handling this correctly. The Medicare tax does apply because this is earned income from services, not passive debt cancellation.

This thread has been incredibly informative! I'm dealing with a similar situation where my company provided me with an interest-free loan for professional development expenses that gets forgiven at 20% per year over 5 years as long as I remain employed. Reading through all the responses here, it's now clear to me that this should be treated as compensation on my W-2 rather than debt cancellation on a 1099-C, since the forgiveness is contingent on my continued employment. The distinction everyone's made between employment-related forgiveness versus general debt cancellation really clarifies things. I was initially confused because I thought any debt forgiveness should result in a 1099-C, but the key factor is that I'm essentially receiving compensation for services (staying employed) in the form of debt reduction rather than cash. This means it should be subject to all employment taxes including Medicare tax. Thanks to everyone who contributed - this discussion has saved me from having to spend hours researching IRS regulations or trying to get through to them on the phone!