Has anyone ever seen any evidence that IRS reads explanations of “adding it in and subtracting it out”? I’m not saying it doesn’t happen, but even on St. Patrick’s Day we have no proof that leprechauns exist.

The Internal Revenue Manual says examiners don’t have access to a TC 150 (tax assessment) document on electronically filed returns. 4.19.2.3.14

In your case, I’m wondering if Line 9 of Form 982 would apply. The company went out of business. Did he have basis in it? Was the basis adjusted by the cancellation of debt at the company level? Did he claim a capital loss for the company stock? Was it an S Corp?

According to one article, if the facts in your case are correct the lender should never have issued a 1099-C to a guarantor in the first place.

https://www.bankruptcysoapbox.com/how-guarantors-can-escape-tax-on-soured-debt/

Which cites this 2002 IRS Info memorandum that deals with guarantors and which concludes:

“Section 108(e)(2) provides that no COD income is realized if payment of the obligation would have given rise to a deduction. A guarantor generally has a claim against the original debtor in an amount equal to the amount of the guarantee that is paid. Assuming such a claim is uncollectible, it would give rise to a bad debt deduction or capital loss for the guarantor if the guarantee were paid. Therefore, cancellation of an obligation that arises pursuant to a guarantee appears to be subject to § 108(e)(2). If the notes under which the taxpayers became personally liable on the indebtedness would entitle them to a claim against the original entity under applicable local law, which would give rise to a bad debt deduction, it could be argued that there is no COD on cancellation of the notes because of § 108(e)(2).”

I would make this argument in an attachment to a paper return, so that if the IRS comes knocking in 18 months and both my client and I have become victims of a pandemic, our survivors can still explain our thinking.