Relief for taxpayers with discharged student loans

Learn about new safe harbor tax relief for taxpayers with discharged federal or private student loans taken out to attend nonprofit or for-profit schools.

January 24, 2020

The IRS recently announced in IR-2020-11 the issuance of Rev. Proc. 2020-11. This revenue procedure provides safe harbor relief to taxpayers who took out federal or private student loans to attend nonprofit or for-profit schools by extending relief provided by prior revenue procedures.

Background: prior relief

Ordinarily, forgiven debt must be included in gross income. The Higher Education Act (HEA) allows the Department of Education to discharge federal loans obtained by students or by their parents for attending a profit or non-profit school that closes. It also provides a Defense to Repayment process which allows discharge of a federal direct loan where the borrower establishes a cause of action under state law. HEA provides statutory exclusions from gross income for loans discharged under these processes.

Rev. Proc. 2015-57 provided tax relief to former students of bankrupt Corinthian College, Inc. (CCI) with discharged federal student loans. Loans discharged by the Education Department (ED) through either the Closed School discharge process or the Defense to Repayment discharge process were not included in gross income. Also, students who claimed education tax benefits were not required to recapture the benefits, even if the benefits were based on tuition paid with a discharged loan.

Rev. Proc. 2017-24 provided similar relief to former students of American Career Institute (ACI) schools with discharged federal student loans. Rev. Proc. 2018-39 expanded the relief to former CCI and ACI students who took out private student loans to attend these schools where the loans were discharged based on a legal settlement.

Rev. Proc. 2020-11: safe harbor for discharged student loans

The IRS and Treasury Department have determined it is appropriate to extend the relief provided in earlier revenue procedures to former students of nonprofit and other for-profit schools (other than CCI or ACI). Rev. Proc. 2020-11 establishes a safe harbor for discharged student loans. The safe harbor applies to nonprofit schools that meet the definition of “institution of higher education” and to for-profit schools that meet the definition of “proprietary institution of higher education” under the U.S. Education Code.

  • Closed School discharge process. 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. The taxpayer should not report the amount from the discharged loan in federal gross income.
  • Defense to Repayment discharge process. A taxpayer whose federal student loan is discharged under the Defense to Repayment discharge process will not recognize gross income as a result of the discharge. The taxpayer shouldn’t report the amount from the discharged loan in federal gross income.
  • Legal settlement discharge actions. A taxpayer whose private student loan is discharged based on a settlement of a legal cause of action resolving various allegations of unlawful business practices against the schools or private lenders will not recognize gross income as a result of the discharge. The taxpayer shouldn’t report the amount from the discharged loan in federal gross income.
  • Education tax benefits. A taxpayer who claimed an education tax credit based on tuition paid with proceeds from a discharged loan does not have to recapture the credit. Likewise, a taxpayer who claimed the tuition and fees deduction based on tuition paid with proceeds from a discharged loan does not have to increase gross income. A taxpayer who claimed the student loan interest deduction on a loan that was discharged does not have to increase gross income.
  • Information reporting. Creditors should not file information returns, such as Form 1099-C, or furnish payee statements for the discharge of any indebtedness within the scope of Rev. Proc. 2020-11.

The revenue procedure notes that even without special relief, most affected students would be able to exclude discharged debt based on the insolvency exclusion or other tax law authority. However, determining whether each affected borrower is eligible for an exclusion would require analysis of each student’s situation, placing a compliance burden on the taxpayer and administrative burden on the IRS. Accordingly, eligible taxpayers may exclude discharged debt from gross income based on the safe harbor.

Effective date. Rev. Proc. 2020-11 is effective for federal student loans discharged by the Closed School or Defense to Repayment process on or after January 1, 2016, and for private student loans discharged on or after January 1, 2016 based on a settlement of a legal cause of action as described earlier. Affected taxpayers may claim a credit or refund based on this revenue procedure for all open years.

Originally published in the 01/22/20 edition of TAX in the News

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