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Will Congress Finally Stop Taxing Disabled Student Loan Borrowers and Bereaved Parents?

It is a little known fact that a forgiven student loan is usually treated as income for tax purposes. While some types of student loan cancellations (e.g. Public Service Loan Forgiveness, closed-school, etc.) are exempt from taxation, forgiveness of the debt due to disability and death is not exempt. There are limited exceptions to taxation that may apply–such as insolvency, where a borrower’s debts exceed his or her assets—but they can be very complicated.

Last month, borrowers who had their student loans forgiven due to their disability or the death of a child (for whom they had taken out the loan) received IRS 1099-C forms in the mail. Many learned then—for the first time—that the canceled student loans could be treated as taxable income. As a result, they may get a surprise tax bill for the forgiven loan amounts. For these borrowers, many of whom are older or veterans with service-connected disabilities, receiving the 1099-C is like salt in the wound. Could this terrible practice finally be coming to an end?

Earlier today, Senators Coons (D-DE), King (I-ME), and Portman (R-OH) reintroduced the Stop Taxing Death and Disability Act. This bipartisan bill would exempt from income tax federal and private student loans that are canceled due to the death of the student or the total and permanent disability of the borrower. A companion bill is expected in the House. This bill was originally introduced last year with strong bipartisan and bicameral support.  The Senate bill (S. 2800) had 17 cosponsors—a mix of Democrats and Republicans. Reps. Roskam (R-IL-6th) and Ron Kind (D-WI-3rd) led the House companion bill, which was unanimously approved by the Ways and Means Committee.

NCLC has been arguing for years that taxing these discharges is grossly unfair to some of the most vulnerable student loan borrowers.  In order to qualify for a disability discharge, borrowers must be able to show that they are no longer able to engage in “substantial gainful activity.”  In other words, they must show that their disability prevents them from being able to support themselves financially.  Yet, despite showing this, and despite the government’s decision that it makes sense to provide these borrowers with financial relief, under current law the IRS can levy a potentially devastating tax burden on these borrowers.

Parent PLUS loan borrowers are also eligible for a death discharge if the student for whom the PLUS loan was taken out is deceased.  Again, the current tax rules mean that parents reeling from the death of their child could also face an enormous, unexpected tax bill at the same time.  The proposed bill would address that unfairness and provide real financial relief to disabled borrowers and to grieving parents.

For now, borrowers who receive a 1099-C should be sure to seek competent tax advice.  Unfortunately, free tax preparation resources are woefully lacking for these low-income borrowers.  The IRS has indicated that cancellation of debt issues for student loan debt are beyond the scope of its Volunteer Income Tax Assistance (VITA) programs.  In some circumstances, however, low-income borrowers may be able to seek assistance from Low Income Tax Clinics.

Did you recently get a 1099-C after your student loans were forgiven due to death of the student or your disability? Tell us your story.

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