This predicament illustrates the term “imputed income.”

I received a substantial scholarship in my junior year of college. After the excitement wore off, people began to tell me that I might have to pay tax on the money.  Furthermore, the scholarship committee called my job and asked them to give me the great news. As a result, the co-worker most threatened by my existence argued to the bosses that since I had received this large scholarship, I no longer needed a job. Shortly, I found myself “laid off.” So it isn’t just the imputed income, it’s the consequences of the resentment that it engenders for which one must pay. ~Deb

http://www.abajournal.com/news/article/tax_time_bomb_awaits_student_loan_debtors_in_forgiveness_programs

There’s a potential “tax time bomb” awaiting those who are current on their student loan debt, in programs that forgive the remaining principal balance of the loan after a period of years usually totaling a decade or two, or even longer.

While they are current on their debt and maintaining their good credit with the help of programs that often determine monthly payments based on their income, tax law requires the forgiven loan balance to be treated as income and taxed accordingly, the New York Times (reg. req.) reports.

The expectation is that such debt will be paid immediately, the newspaper notes.

Meanwhile, it is entirely possible, for many such borrowers, that the principal balance at that point could exceed the total original amount of the debt. Depending on the individual’s then-current income tax bracket, that could mean a $10,000 tax bill for a person who has a $40,000 loan balance.