Today’s
college students often leave school with an overwhelming amount of
debt. In some cases, student loans are discharged (also known as being
cancelled or forgiven). In other cases, these loans are paid off by an
employer. Both actions have tax consequences for the student loan borrowers.
We’ll explain the tax implications, but first, let’s cover some necessary
background information.
Cancellation
of Debt Tax Basics
For federal
income tax purposes, the general rule is that a taxpayer’s gross income
includes any cancellation of debt (COD) income — unless one of several tax-law
exceptions applies. The availability of exceptions (found in Section 108 of the
Internal Revenue Code) depends on various factors such as the use of the loan
proceeds and the borrower’s financial condition at the time the “COD event”
occurs.
Here are some of the exceptions:
- The insolvency exception. Taxpayers can exclude COD income to the extent they are insolvent when the COD event occurs. Taxpayers are insolvent when their liabilities exceed the fair market value of their assets immediately before the COD event.
- The bankruptcy exception. This applies to debts that are discharged in bankruptcy proceedings.
- The public service employment exception. COD income from certain forgiven student loans is excludable. To qualify, the loan document must state that all or part of the student loan debt will be cancelled if the student works for a certain period of time in a specified profession for a specified type of employer. Basically, this is a public service requirement. For example, some teachers who work for five years at a school that serves low-income families may be eligible for forgiveness on up to $17,500 of certain federal loans.
Department of
Education Loan Discharge Procedures
There are also some non-tax-law provisions that allow
student loan borrowers to exclude COD income when the U.S. Department of
Education discharges federal student loans. For this purpose, federal student
loans include federal Family Education Loans, federal Perkins Loans and federal
Direct Loans. For example:
Read more on... RELIEF
FROM STUDENT LOAN DEBT: WHAT ARE THE TAX IMPLICATIONS?
Author: MLRPC
