In which case will the taxpayer be able to exclude all income from their canceled debt?

The ability to exclude income from canceled debt is primarily determined by the taxpayer's insolvency status at the time the debt is canceled. A taxpayer can exclude canceled debt from their taxable income to the extent that they are insolvent, meaning that their total liabilities exceed their total assets.

In the selected case, the taxpayer had $12,500 of debt canceled, and prior to the cancellation, they were insolvent by $13,000. This means that their liabilities already exceeded their assets by $13,000, which is greater than the amount of debt canceled. As a result, the full amount of the canceled debt can be excluded from their income because the taxpayer was insolvent to a degree that fully covers the amount of canceled debt.

In comparison, the other cases do not meet the criteria for exclusion. In those scenarios, the amount of cancellation is either less than or only partially covered by the amount of insolvency, meaning that only a portion of the canceled debt may qualify for exclusion, if any at all. The correct answer reflects the scenario where the taxpayer's insolvency not only absorbs the canceled debt but exceeds it, allowing for complete exclusion from taxable income.