IRS Provides Additional Debt Relief for Certain Student Loan Borrowers

(Parker Tax Publishing January 2020)

The IRS established a safe harbor extending relief to certain taxpayers who took out federal or private student loans to finance attendance at a nonprofit or for-profit school. The IRS will not assert that a taxpayer within the scope of the safe harbor recognizes gross income as a result of the discharge of a student loan under the Department of Education's Closed School or Defense to Repayment discharge process, or where the private loans are discharged based on a settlement of a legal cause of action against nonprofit or other for-profit schools and certain private lenders. Rev. Proc. 2020-11.

Background

Under the Higher Education Act of 1965 (HEA), the Closed School discharge process allows the Department of Education (ED) to discharge a federal student loan of a student who was attending a school at the time it closed or who withdrew from the school within a certain period before the closing date. The HEA provides statutory exclusions from gross income for federal student loans discharged under the Closed School discharge process. The HEA also provides a Defense to Repayment process which allows the ED to discharge a federal Direct Loan if the 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.

Rev. Proc. 2015-57 and Rev. Proc. 2017-24 provided relief for taxpayers who took out federal student loans to finance attendance at a school owned by Corinthian College, Inc. (CCI) or American Career Institutes, Inc. (ACI), respectively, and whose loans were discharged under the Closed School or Defense to Repayment discharge process. Rev. Proc. 2018-39 provides relief for taxpayers who took out private student loans to finance attendance at a school owned by CCI or ACI and whose loans were discharged based on a settlement of a legal cause of action resolving various allegations of unlawful business practices, including unfair, deceptive, and abusive acts and practices against CCI, ACI, and certain private lenders.

Rev. Proc. 2015-57, Rev. Proc. 2017-24, and Rev. Proc. 2018-39 provide the following relief: (1) the IRS will not assert that these taxpayers must recognize gross income resulting from the discharge of these federal and private student loans; (2) the IRS will not assert that these taxpayers must increase their gross income by the amount of certain tax credits or deductions related to the discharged federal and private student loans; and (3) the IRS will not assert that the creditors of these discharged loans must file information returns and furnish payee statements under Code Sec. 6050P as a result of discharging these federal and private student loans.

In mid-January, the IRS issued Rev. Proc. 2020-11, in which it said that it is aware that additional taxpayers may have federal and private student loans discharged under the circumstances described in Rev. Proc. 2015-57, Rev. Proc. 2017-24, and Rev. Proc. 2018-39. The IRS therefore is extending the relief provided in those procedures to taxpayers who took out federal and private student loans to finance attendance at nonprofit or other for-profit schools not owned by CCI or ACI where the federal loans are discharged by ED under the Closed School or the Defense to Repayment discharge process, or where the private loans are discharged based on a settlement of a legal cause of action against nonprofit or other for-profit schools and certain private lenders. The IRS observed that, as in the prior procedures, most borrowers would be able to exclude from gross income all or substantially all of the discharged amounts based on the insolvency exclusion under Code Sec. 108(a)(1)(B); fraudulent or material misrepresentations made by such nonprofit or for-profit schools or certain private lenders to the students; or other tax law authority. However, the IRS explained that determining whether one of these exclusions is available to each affected borrower would require a fact intensive analysis of the particular borrower's situation and would impose excessive burdens on taxpayers and the IRS.

Safe Harbor Relief

Under Rev. Proc. 2020-11, a taxpayer whose federal student loan is discharged under the Closed School or the Defense to Repayment discharge process, or whose private student loan is discharged based on a settlement of a legal cause of action resolving allegations of unlawful business practices against nonprofit or for-profit schools or private lenders that made student loans to finance attendance at these schools, will not recognize gross income as a result of the discharge. Such taxpayers should not report the amount of the discharged loan in gross income on their federal income tax returns.

The IRS will not assert that a taxpayer within the scope of Rev. Proc. 2020-11 must increase his or her taxes owed in the year of a discharge, or in a prior year, as a result of a discharge, if in a prior tax year he or she received an education tax credit under Code Sec. 25A attributable to payments made with proceeds of the discharged loan. In addition, the IRS will not assert that a taxpayer within the scope of Rev. Proc. 2020-11 must increase his or her gross income in the year of the discharge as a result of a discharge, if in a prior tax year he or she took a deduction under Code Sec. 221 for interest paid on a discharged loan or under Code Sec. 222 for payments of qualified tuition and related expenses made with proceeds of the discharged loan.

The IRS also will not assert that a creditor that is an applicable entity, as defined by Code Sec. 6050P and the regulations thereunder, must file information returns and furnish payee statements for the discharge of any indebtedness within the scope of Rev. Proc. 2020-11. According to the IRS, the filing of such information returns could result in the issuance of underreporter notices to taxpayers and the furnishing of such payee statements to taxpayers could cause confusion.

Effective Date

Rev. Proc. 2020-11 is effective for federal student loans discharged by ED in tax years beginning on or after January 1, 2016, under the Closed School or Defense to Repayment discharge process, and for private student loans discharged in tax years beginning on or after January 1, 2016, based on a settlement of a legal cause of action resolving various allegations of unlawful business practices, including unfair, deceptive, and abusive acts and practices against the nonprofit or for-profit schools or certain private lenders. Taxpayers to whom Rev. Proc. 2020-11 applies may claim a credit or refund for an overpayment of tax for years for which the statute of limitations under Code Sec. 6511 has not expired.

For a discussion of the exceptions to the discharge-of-indebtedness income rule, see Parker Tax ¶72,315.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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