They still have to pay income tax on the abolished debt, but for someone in trouble like this that's probably at a pretty low marginal rate. The IRS doesn't want me paying for things by loaning the seller the price and then forgiving the debt as a way of getting around taxes, though that policy ends up being unfair in this situation.
If forgiven debt is counted as income, one can unexpectedly get into a much higher marginal rate bracket than usual. Not sure if IRS allows to amortize it over multiple years or something like that...
That is true. And no, much like income, it's reported in the current year. It's very much just income. No different than if they gave the guy a check to pay his own debt.
