It sounds like there are two questions: is a short sale possible, and can the tax consequences be forgiven on the canceled debt.
For the shortsale, I've included a link to the FHA site: basically, start by talking to your lender before talking with anyone else. Once your lender has given you some guidance, there will be some items you will need to get prepared. The short sale negotiator I use has a list.In general it includes two years of tax documents, bank information, employment and pay information and such. Most importantly, there is a personal statement from you explaining why the bank should consider that there is a hardship, what that hardship is, and what you have done to stave off the bank's eventual loss.
While it seems like a lot, once things are together, that aspect is complete. Based on the bank's guidance, they may recommend bringing a realtor on, and there may be some requirements for the listing. The Realtor will ensure the listing has the disclosures to potential buyers about the short sale. Some people hire attorneys to represent their interests before the bank and to facilitate a transaction, others either hire a negotiator or use a realtor who has a negotiator available for the sale: in some cases this can be done without additional direct expense to the transaction, so shopping around is wise.
There is some legislation that removes from taxable income the cancellation of debt of the primary residence of a tax payer. Naturally, there are rules to follow and exceptions to those rules which may allow for the exclusion. The legislation I speak of is set to expire at the end of 2012: unless it extends beyond, this provision of the tax code is a mote point. That leaves you with the potential strategy of claiming insolvency when faced with the tax consequences. For this, I recommend reviewing all the information with either a CPA, an Enrolled Agent (allows representation before the IRS), or a lawyer familiar with tax and real estate issues. I recommend that this be your starting point before even contacting your bank: get the right advice from an attorney and they can guide all aspects: once again, shopping for the right one is important.
Here is the link to the FHA site:
Feel free to contact me on this to begin the process.