The IRS recently announced it was expanding aid to taxpayers indebted to federal or private student loans for attendance at both non-profit and for-profit schools. Rev Proc 2020-11 issued January 15, 2020, and it provides safe harbor relief against income recognition after loan discharge for the following three specific situations.

  1. Any taxpayer whose private student loan debt is discharged based on a settlement of a legal cause of action against non-profit or for-profit schools or private lenders gets the pass on recognizing the income. This seems totally fair and reasonable. It encompasses the situation where a borrower, former borrower or parent on behalf of either sues and alleges some sort of unlawful business practice. Those of you who have read my posts in the past know implicitly I am no fan of predatory lending and the resulting destruction student loan payments and non-payments have caused. This is totally CBM – Cool By Me.
  2. Relief is similarly provided to those unfortunate taxpayers whose federal loans are discharged under the “Closed School” discharge process – progeny of the Higher Education Act of 1965 and enforced by the Department of Education. It covers said unfortunate souls attending a school at the time it’s shuttered or withdrawing from the school within a certain period prior to its closing. No reasonably minded person would take any issue with this completely proper relief.
  3. Well, you probably already figured out Door #3 is the one I’m calling out. Relief is also afforded to taxpayers whose federal student loan debt is discharged under the “Defense to Repayment” discharge process – another statutory provision of the Higher Education Act of 1965 whereby the Department of Education can cancel a federal loan if the school’s actions would give rise to a cause of action against the school under applicable state law. This is decidedly NCBM – Not Cool By Me.

I am not an education lawyer. And maybe the question is more aptly put to the Department of Education instead of IRS since IRS is utilizing a Department of Education statute and resulting protocol. But this seems terribly problematic. The would discussed above certainly implies that no adjudication is necessary on the cause of action. A taxpayer could presumably only present a defense to repayment which would suffice under state law. I don’t see anything here about legal settlements (as with the Cool By Me #1 above) or a definitive finding by a court that the school screwed up – just an easy hurdle for the taxpayer to jump. Far be it for me and my sensibilities to argue in favor of any educational institution against a single taxpayer, but this is not above board.

And here is why it should matter to you. Enterprising taxpayers may have now been given a super priority status to fight that 1099-C. 1099-Cs are required when $600 or more in debt is forgiven. Those are never any fun. Form 982 is extraordinarily limited as to the exceptions to discharge inclusion. If you’re not dealing with real property indebtedness, you’re basically limited to Title 11 bankruptcy or insolvency. And always remember we’re talking balance sheet insolvency (where liabilities exceed assets immediately before discharge), not the common law definition of insolvency as not being able to pay debts as they become due. So, what will you do if a taxpayer asks for your esteemed counsel on inclusion based on #3 above? Let’s not speculate on the reason for the discharge, but say the client brings you a 1099-C from XYZ College as part of this season’s 1040 prep. Assume client is not insolvent and has never filed Title 11. Client proceeds to tell you about vaguely recalling that the college was accused of marketing exaggerated employment figures for graduates. These things happen all the time, right? I believe Client should now deservedly be referred to as “Astute client”. Astute client then tells you he or she does not want to declare the 1099-C income because such misdirection would give rise to a cause of action. Never mind that no formal allegation has ever been leveled against the school in court or elsewhere. Also, forget XYZ College has been given no opportunity to defend itself and may be hearing about this indiscretion for the first time. Tax professional – you are directed to concentrate on would, not did. Your job is to beat the bush for tax savings to shake out for that paying client. Are you going to sign that return? I wouldn’t. Sounds like you would be inviting that pesky libel thing. Or is it slander? Slander is spoken; libel is written. Sorry, I don’t usually digress to mnemonic alliteration.

But again, I want to emphasize that IRS has borrowed ostensible determinations here from the Department of Education. IRS specifically refers to its administrative burden if it were to partake in any fact-intensive analysis of the borrower’s financial situation. These IRS burdens, coupled with difficult taxpayer compliance, are usually the correct justifications for tax safe harbors. But this harbor may run too deep as to invite sharks looking to take improper advantage and avoid §108 income.

For its emanating public policy, then, I applaud IRS for recognizing these borrowers, and possibly the parents who took out loans on behalf of their kids, deserve a break. Maybe Elizabeth Warren’s pledge to forgive all student loan debt doesn’t strike an equitable balance – particularly to those who repaid their debt in full. But this revenue procedure is no counter-balance, and it may present some difficult challenges for 1040 preparers going forward.

Want to hear about other difficult challenges regarding education? Funding college costs qualifies. Learn some strategies for escalating college costs and long-term care as well by signing up for Long-term Care and College Saving: Critical Topics for Today’s Practitioner (LCCS).

Nick Spoltore is VP of Tax & Advisory Content for Surgent CPE. Mr. Spoltore is a graduate of the University of Notre Dame and of Delaware Law School. Before joining Surgent, he practiced tax and business law at the firm of Heaney, Kilcoyne in Pennsylvania and also in Delaware.

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