Borrowers who had their student loans canceled due to death or disability in 2015 should look out for a 1099-C in the mail this week.
With a few exceptions, canceled debt is treated as income. Federal student loan borrowers are eligible for the cancellation of their loans if they are totally and permanently disabled or due to death. Parent PLUS loan borrowers are also eligible for the death discharge if the student for whom the PLUS loan was taken out is deceased. While some types of student loan cancellations (e.g. Public Service Loan Forgiveness, closed-school, etc.) are exempt from taxation, cancellation of debt due to disability and death are not.
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. Yet, despite showing this, the IRS can levy a potentially devastating tax burden on the borrower. While there have been efforts to address the tax consequences of some of the other types of student loan cancellations, death and disability are often left out.
Depending on the borrower’s circumstances, dealing with cancellation of debt issues can be very complicated. There are some exceptions to taxation that may apply, such as insolvency – where a borrower’s debts exceed his or her assets. Borrowers who receive a 1099-C should be sure to seek competent tax advice. Unfortunately, resources are woefully lacking for low-income borrowers. The IRS has indicated that cancellation of debt issues for student loan debt are out of the scope of their Volunteer Income Tax Assistance (VITA) programs. In some circumstances, low-income borrowers may be able to seek assistance from Low Income Tax Clinics.