An S corporation is a kind of special case for reporting cancellation of debts, whether they involve mortgages or other indebtedness.
In short, a solvent S corporation gives the proceeds from cancellation of debt directly to its shareholders, and they must pay tax on that income. It is reported on IRS Form 1120S as “Other income.”
A bankrupt or insolvent S corporation is entitled to exclude the income coming from debt cancellation on its tax return. It shows that on IRS Form 982. The underlying shareholders generally do not owe tax on that income. Be cautious, though. Some tax could be due when an S corporation is insolvent on its books, but has not yet filed bankruptcy. That’s a time to check with a tax professional such as EricJohn Ltd.