Today, the Department of Education released a new report outlining a series of statutory, regulatory, and administrative recommendations in response to President Obama’s Student Aid Bill of Rights. There are some good recommendations for borrowers (e.g. see the recommendation to increase the amount of Social Security benefits that should be protected from offset). The Department also called for changes to the tax code to ensure that borrowers in an income driven repayment plan and who have a defense to repayment are not stuck with a large tax bill when their loans are cancelled.
Unfortunately, the Department left out two very important categories of borrowers in its tax recommendations: borrowers with disabilities and survivors of those who receive death discharges.
1) Borrowers who get their loans discharged due to disability are some of the most vulnerable 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. Yet, despite showing this, the IRS can levy a potentially devastating tax burden on the borrower. See our policy brief on this issue from 2013.
2) Student loans forgiven due to death are also treated as taxable income. In addition to the estate of deceased borrowers, parents who took out PLUS loans for their kids also face tax consequences in the unimaginable circumstance that their child dies. Their stories are heartbreaking.
In the report, the Department outlined some important steps to streamline the process for Veterans and Social Security recipients to access disability discharges. Yet it failed to acknowledge the tax consequences for these borrowers once the cancellation occurs.
Exempting federal student loans discharged because of death or total and permanent disability from cancellation of debt income would ensure fairer tax treatment for some of the most vulnerable student loan borrowers. It is unacceptable to exclude these categories when considering other important changes to the tax code.