The Internal Revenue Service (IRS) has issued guidelines for certain taxpayers who have purchased private student loans to fund attendance at a non-profit or for-profit school. The orientation offers relief to students whose loans have been canceled by the Ministry of Education and who meet specific criteria.
Typically, a debt forgiveness is a taxable event: Debt forgiveness is treated as income for the debtor. Under these recent guidelines, affected students will not recognize income following release. This means that the taxpayer does not have to report the loan amount released on his federal income tax return.
The break applies to students who:
- Participation in the process of leaving closed school. The closed school release process allows the Department of Education to pay off a federal student loan obtained by a student (or the student’s parent) who was attending the school at the time of its closure or who withdrew from the school just before it closed.
- Borrowers who participated in the Defense to Reimbursement discharge process. The repayment defense process allows the Department of Education to pay off a federal direct loan obtained by a student (or the student’s parent) if the borrower can prove that a school’s actions would give rise to a cause of action against the school under applicable state law. .
- Borrowers who have participated in court settlement discharge actions. Several lawsuits have been brought by federal and state government agencies to resolve allegations of illegal business practices, including unfair, deceptive and abusive acts and practices, against for-profit schools and specific private lenders who offered loans students in these schools.
Guidance is an extension of the relief provided for in Rev. Proc. 2015-57, Rev. Proc. 2017-24 and Rev. Proc. 2018-39. As with previous guidelines, the Treasury Department and the IRS believe that the federal government and private student loan borrowers may be able to exclude canceled loans under the insolvency exclusion under article 108 (a) (1) (B). A taxpayer is considered insolvent if the taxpayer’s liabilities exceed his assets immediately before discharge.
Student loan borrowers can also exclude income from fraudulent or material misrepresentation made by schools or student-specific private lenders or other tax authority.
However, determining which exclusions might apply to individual taxpayers would require a detailed examination of the facts and circumstances of each taxpayer. This creates a significant compliance burden on taxpayers and a disproportionate administrative burden on the IRS. As a result, the IRS has established a safe zone – if they meet the criteria – to allow these students some relief.
Relief is also extended to any creditor who would otherwise be required to file information returns and provide statements to affected students. To avoid confusion, the IRS strongly recommends that creditors do not provide students (or the IRS) with a Form 1099-C, Debt Cancellation – Internal Revenue Service.
For more information, see Income procedure 2020-11 (download in PDF format).