student loan forgiveness

Student Debt Forgiveness At Closed Universities

April 7, 2017 : Lynn Ebel - The Tax Institute

In August of 2016, the Department of Education barred ITT Technical Institute from accepting new students with government loans. As a result, the school terminated all operations at its 136 campuses. Now around 35,000 students are now left to wonder would happen to both their education credits and their student loan debt.

This is not the only higher education institution that closed its doors recently: Regency Beauty Institute, Webster University, Everest College, and Corinthian Colleges are other nationally recognized colleges that closed its doors.

Students affected by the ITT closure (and similar for-profit college closings) have two options:

  1. Apply for a discharge of student loan debt (student debt forgiveness).
  2. Transfer credits to an eligible institution to continue their studies.

1 – Student Loan Debt Forgiveness

Students can apply for a “closed school discharge” where Federal Direct Loans, Federal Family Education Loans (FFEL), or Federal Perkins Loans are forgiven.

Taxation: Normally when debt is discharged. it results in taxable income. Luckily, student loan debt cancelled under a Closed School Discharge is not taxable. The Higher Education Act (HEA) provides a statutory exclusion from gross income for federal student loans discharged under this process. So, if a student’s federal student loan is forgiven as a Closed School Discharge, the student does not have to recognize income from the forgiven debt. This may be ideal for a student who wasn’t far into their schooling.

Treatment of Prior Education Tax Credits Claimed

If a student opts to have your student loan discharged, any education tax credits (i.e., the American Opportunity Credit or Lifetime Learning Credit) claimed on their prior-years’ tax returns would not have to be paid back.

In this case, a later cancellation of student loan won’t likely require students to recapture educations credits that they claimed in prior years.

2 – Transfer Credits

Under this discourse, students can keep credits and transfer them to another school. If you have any student loan debt cancelled, it is unclear at this time if the IRS will allow this to be nontaxable to you.

Taxation: Students may seek to have federal student loan forgiveness under the Defense to Repayment discharge process, or “Borrower Defense”. With this process, you are not offered an exclusion for loans forgiven. However, there were two previous rulings that allowed students of a particular school to not be taxed on the cancelled student loans because the IRS concluded that most borrowers would qualify for the insolvency exclusion or another exception:

  • Corinthian Colleges – Rev. Proc. 2015-57
  • American Career Institute (ACI) – Rev. Proc. 2017-24

We are still waiting on guidance of whether this could also apply to students of ITT.

Lynn Ebel - The Tax Institute

Lynn Ebel - The Tax Institute

H&R Block

Lynn Ebel, JD, LLM, is manager of The Tax Institute's research department. Lynn specializes in real estate tax issues, including property transfers, passive activity losses, and bankruptcy issues.

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