Tax Relief Available for Discharge of Certain Student Loan Debts

Student loans account for a substantial portion of this country’s total indebtedness. Outstanding student loan debt is estimated at $1.5 to 1.6 trillion. The U.S. Department of Education (DOE) holds almost all of this debt, giving it substantial power over repayment, forgiveness, and discharge. Normally, discharge of debt is considered a taxable event. The IRS has established revenue procedures creating a “safe harbor” for discharges under certain DOE programs. Our Los Angeles tax advisors observed that it recently issued a new revenue procedure expanding that safe harbor.

Student Loan Discharge Programs

The DOE maintains several programs that allow partial or total discharge of student loan debt in specific situations. These programs only apply to student loans made or guaranteed by the DOE.

Closed School Discharge

The Higher Education Act (HEA) of 1965, as amended in 1986, directs the DOE to discharge the student loan debt of a borrower who is unable to complete their studies because their school closes, or because of certain fraudulent actions on the part of the school. Borrowers must apply to the DOE to obtain a discharge under this program. They must be able to demonstrate that they were either enrolled in the school or on an “approved leave of absence” at the time of closure, or that they withdrew 120 days or less before the school closed.

Defense to Repayment Discharge

The HEA also directs the DOE to create regulations “specify[ing]…acts or omissions of an institution of higher education [that] a borrower may assert as a defense to repayment of a loan.” The “borrower defense” is available to individuals who have obtained a judgment against a school for breach of contract, fraud, or other claims

IRS “Safe Harbor” Procedures for Student Loan Discharge

In June 2015, the DOE issued a press release addressing debt relief for students who attended a nationwide chain of for-profit career colleges accused of deceptive advertising and other fraudulent practices under federal and various state laws. The entire chain of schools closed in mid-2015. Soon after the DOE issued its announcement, the IRS issued Rev. Proc. 2015–57, which stated that, with regard to these schools, the agency would not include debts discharged under the Closed School or Defense to Repayment programs in borrowers’ gross income.

In Rev. Proc. 2017–24, the IRS expanded relief for student loan borrowers affected by the scandal. It stated that borrowers who received a discharge would not be taxed on education credits obtained from tuition payments made with student loans, nor on deduction of student loan interest payments.

Rev. Proc. 2018–39 extended the provisions of the earlier procedures to the discharge of private student loans used for the schools involved in the scandal.

With Rev. Proc. 2020-11, the IRS has expanded the earlier procedures to include other for-profit and nonprofit schools, not just those involved in the 2015 legal proceedings. It applies to loans discharged through the Closed School and Defense to Repayment programs, and to private loans discharged as part of a legal proceeding against a school for claims like fraud. It excludes these discharge amounts from borrowers’ gross income, and exempts tax credits and deductions obtained as a result of the expenditure of these student loans from recapture.

If you have questions about resolving a matter involving taxes in California, please contact the Enterprise Consultants Group today online or at (800) 575-9284. Our tax advisors are available to answer your questions, address your concerns, and discuss your rights and options.

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