Fix for Borrowers with Loan Discharges Comes Up Short in Tax Reform

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Update 11/15/2017: The latest version of the Senate tax bill, released on November 14, now includes this provision, as well. That's great news for borrowers and families of those who are eligible for death and disability discharges. But neither bill includes a similar exemption for other types of student loan discharges.

For all the tax reform provisions that will take away benefits from borrowers and colleges, there’s one important addition in the House legislation--excluded from the Senate’s version of tax reform that was published over the weekend--that will help vulnerable students and their families: making student loan discharges due to death or disability nontaxable income.

Currently, borrowers have the right to have their federal student loans wiped away when they die or are determined to be totally and permanently disabled. But that small relief is short-lived, when the borrower or his family learns that he may owe taxes on the amount that was discharged. For instance, a veteran wounded in Afghanistan recently received forgiveness on his student loan debt -- before learning the IRS expected him to pay $62,000 in income taxes on that forgiveness.

The provision included in the House’s tax reform bill, echoing a bipartisan bill introduced in the Senate earlier this year by Sens. Portman (R-OH), Coons (D-DE), and King (I-ME), would fix that problem, both for federal and private student loans discharged for those reasons--an important resolution to a problem that plagues some of the most vulnerable borrowers. But it begs two questions: Why wouldn’t the Senate follow suit on this provision? And why wouldn’t Congress fix this problem for the other student loans it forgives?

Specifically, the Department of Education forgives loans for a whole host of other purposes--at the end of 20 or 25 years of payment on an income-driven repayment plan, for borrowers whose colleges lied to them, and in cases where borrowers never should have gotten the loan in the first place. But in all of these cases, borrowers typically owe taxes on the amount of the loan that is discharged, setting them up for a big hit on their taxes if they make use of the options Congress set out in law. While Treasury has made special exceptions in a few limited cases--for instance, for Corinthian Colleges and American Career Institute borrowers who submit and have approved borrower defense claims--on the whole, borrowers are faced with a potentially expensive choice.

And it’s not hard to imagine how the “taxable income” catch might cause problems in such cases when you look back at government efforts to make it easier for permanently disabled borrowers to get their loans discharged. In 2015, the Department of Education and the Social Security Administration teamed up to automatically identify borrowers who have already been deemed totally and permanently disabled and therefore qualify to have their loans discharged, too. But the Department couldn’t automatically discharge their loans, because of the tax liability those disabled borrowers would incur. Instead, it had to settle for sending borrowers letters notifying them of their eligibility, suspending their payments for a short time period so they could complete the application, and processing them later. In the first couple of data matches, the federal agencies identified about 400,000 borrowers as potentially eligible. Similar efforts to help borrowers access the benefits for which they’re eligible, including income-driven repayment forgiveness and borrower defense, are also forced to stop short of providing the benefit.

To date, there aren’t too many borrowers who fall in these categories, given that spikes in income-driven repayment enrollment and claims filed by harmed students looking for a borrower defense discharge are both relatively recent. But there’s a growing pileup of students who may face an unexpected tax liability. For instance, there are well over 70,000 borrower defense claims waiting in limbo at the Education Department right now. And while many of them will pay off their loans rather than qualifying for forgiveness, an unprecedented 6 million Direct Loan borrowers are enrolled in income-driven repayment plans today. (Check out this report for examples of borrowers’ tax liability after receiving loan forgiveness.)

At the end of the day, when Congress promises a borrower forgiveness, it should be provided to him--without the added insult to injury of an expensive tax payment. Members of Congress owe it to borrowers--and especially to our veterans--to fulfill those promises they have made.

Author:

Clare McCann is the deputy director for federal higher education policy with New America's Education Policy program. She previously served as a senior adviser on higher education policy at the U.S. Department of Education.