IRS Issues Guidance Regarding Discharge of Student Loans

IRS Issues Guidance Regarding Discharge of Certain Student Loans

As any individual who has taken out a student loan or who holds student debt knows, a student loan is forever – unless you can pay it off. In other words, it is highly unlikely that the federal courts will permit the discharge, or wiping away, of the loan debt. However, there are certain limited circumstances where discharge of student loan debts is, indeed, appropriate and likely to be granted by the federal courts. The Department of Education has developed a”Closed School” and “Defense to Repayment” discharge processes that can be used by individuals with student loans who meet certain criteria and circumstances.

For instance, some students are permitted to receive a discharge because they have a serious medical condition or disease and it would constitute an undue hardship to repay the loan. In other circumstance, attendees of certain colleges and higher education institutions might be entitled to discharge due to wrongdoing or misrepresentations made by their school.

IRS exchange of information

Unfortunately, the IRS’ interpretation of the U.S. tax Code means that even if you are able to successfully have your students loans discharged, you aren’t quite free and clear of further obligations. For many individuals, the tax time bomb triggered by a student loan discharge can have profoundly negative consequences on the individual’s finances and bottom-line.

Former Students of Corinthian Colleges, Inc. Likely to Qualify for Loan Discharge

According to estimates set forth by the Department of education, at least 50,000 former students and their parents of the now defunct Corinthian Colleges are likely to be eligible for a loan discharge. Students may be eligible for the discharge if they were attending the school when it shut down or within a certain time period prior to the school’s cessation of operations. Typically, and as set forth in the documentation for the Department of Education’s “Defense to Repayment” a student or other qualifying party is entitled to a loan discharge when “a student loan borrower establishes, as a defense against repayment, that a school’s actions would give rise to a cause of action against the school under applicable state law.” See 20 U.S.C. § 1087e(h); 34 C.F.R. § 685.206(c). However, before students take action they should engage in careful tax planning and consider the potential effects of the discharge.

The IRS Definition of “Income” Is Extremely Broad and Includes Forgiven Debts

Under the Internal Revenue Code, the concept of what constitutes income is extremely broad. Typically, discharged or forgiven loans are considered imputed income that the individual must report and pay tax. However, there is a great deal of nuance concerning whether students who have loans discharged are required to report and pay taxes on the discharged loans.

For students who secure a discharge through the Closed School process, IRS Revenue Procedure 2015-57 recognizes that, “…a taxpayer whose Federal student loan is discharged under the Closed School discharge process will not recognize gross income as a result of the discharge, and the taxpayer should not report the amount of the discharged loan in gross income on his or her Federal income tax return.” Thus it is likely that borrowers of this type will be able to secure relief. However, because the granting of relief is dependent on the individualized circumstances and factors surrounding the issuances of your student loan, taxpayers should seek careful individualized guidance from an experienced tax attorney prior to taking action.

As for students who may otherwise utilize the Defense to Repayment Discharge Process to discharge student loans, the tax treatment of these discharges is less clear. IRS Revenue Procedure 2015-57 recognizes that the Higher Education Act of 1965 does not exclude discharged student loans from gross income inclusion. However, certain wrongful acts, such as fraud, connected with the original transaction may give rise to the right to partial discharge when the debtor is insolvent.

IRS tax law

The IRS and Department of Treasury believe that “most borrowers whose Corinthian student loans are discharged under the Defense to Repayment discharge process would be able to exclude from gross income all or substantially all of the discharged amounts based on fraudulent misrepresentations made by the colleges to the students, the insolvency exclusion, or another tax law authority.” However, the guidance continues by cautioning readers that determining whether one or more of these exceptions is available requires a individualized and fact-intensive review of the individual’s facts and circumstances. However, due to concerns regarding the effective administration of the tax code the IRS has stated, “the IRS will not assert that a taxpayer within the scope of this revenue procedure recognizes gross income as a result of the Defense to Repayment discharge process.”

Concerns over a Student Loan Discharge?

If you think that you may be eligible for a student loan discharge due to attending a closed school like Corinthian University or due to other wrongdoing by your university or college, a tax lawyer in Los Angeles like Robert Hoffman, who can help you understand the potential tax consequences of pursing such action. To schedule a free and confidential tax consultation call our firm at 800-897-3915 or contact us online today.

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