I found this article which states your short sale clients may end up with a huge tax burden.  If you are doing short sales - it is in your best interest to always look out for your clients.  Here are the main points I took from this article.

If the bank sells your home for less than the amount left on your mortgage, any forgiven debt can be treated as taxable income. The IRS even has a special form for reporting this windfall: the 1099-C. The C stands for cancellation of debt and the law says cancelled debt is taxable just the same way salary is.

There's a very important exception to the debt-relief-equals-taxable-income rule. Although lenders must send 1099-C forms reporting taxable income whenever cancelled debt is $600 or more, the tax bill itself is forgiven if the homeowner is bankrupt or insolvent.

Insolvency means your debts (including that mortgage) exceed the value of all your assets. Let's go back to the $300,000 mortgage and the $260,000 short sale. If you had no assets at all, none of the $40,000 of debt relief would be taxable. If you had more than $40,000 of assets in addition to your home, however, the full $40,000 would be taxed. What if you had $25,000 of assets in addition to your home? Then $25,000 would be taxable and the other $15,000 could be excluded from income under the insolvency rule. (You use IRS Form 982 to claim the exclusion.)

Williams says most of the short sales he's been involved with actually result in little or no taxable income to the seller, because they have no assets. "They may have some furniture and a little equity in a car, but their big asset is their house," he explains.

It's clear, though, that plenty of people get burned by the rule that taxes forgiven debt. Twice in recent history, in fact, Congress has passed laws giving some people a pass on forgiven debt, regardless of their assets. But don't think Congress is a softie: The exceptions were for victims who lost their homes due to the terrorists attacks of 9-11 or Hurricane Katrina. Legislation has been introduced in both the House and Senate to grant general relief to homeowners who lose their homes to foreclosure. The National Association of Realtors is solidly behind it. But, frankly, the prospects are not good.

If you benefit from debt forgiveness after a foreclosure or short sale, be sure to make a careful inventory of your assets and liabilities at the time. You'll need it to claim an exception under the insolvency rule.

Hope this helps,

Sean