IRS Moves to Prevent Defrauded Borrowers from Massively Overpaying Taxes Through Adoption of a New Revenue Procedure

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We welcome first-time guest blogger Alex Johnson to PT. Alex is a second year law student enrolled in Harvard’s Predatory Lending Clinic.  Prior to law school Alex worked as a financial statement auditor and holds an inactive CPA license.  The Predatory Lending Clinic does amazing work.  It regularly receives press coverage for the work it does on behalf of students who did not receive the education they sought.  You can see some of that coverage here, here and here.  Keith

The IRS recently issued revenue procedure 2020-11 which extends the relief provided under three prior IRS revenue procedures: 2015-57, 2017-24, and 2018-39.  Generally, revenue procedure 2020-11 provides relief to taxpayers who obtain a Federal or private student loan discharge under certain circumstances.  It also provides relief to those taxpayers’ respective creditors who were required to file information returns and payee statements pursuant to section 6050P of the IRC.  Through this revenue procedure the IRS takes the position that all borrowers who have their loans discharged under either a closed school discharge, defense to repayment discharge, or as part of a legal settlement discharging private loans based on claims of school misconduct do not have to include the prior loan amount as gross income.  Further, to prevent confusion and simplify the process of filing taxes, entities normally required to issue a 1099-C will not have to if one of the above situations applies.

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Harvard’s Project on Predatory Student Lending (the Project) represents students asserting their rights against predatory for-profit colleges and the Department of Education.  The Project uses individual cases and class actions to assist individuals who decided to better their life through higher education but were deceived by false promises and predatory practices.  Before the IRS issued this revenue procedure, the Project had taken steps to protect their clients against burdensome 1099-Cs and guard against the possibility that they would pay unnecessary tax on cancelled debt.  In one recent case, the Project worked to obtain a Private Letter Ruling from the IRS regarding a substantial amount of institutional debt cancellation won through litigation.

Defrauded students already face an uphill battle enforcing their legal right to a loan discharge.  Because many people defrauded by the for-profit college industry have high loan balances and low income, even when they were able to discharge their loans the tax consequences could be devastating.

The IRS and consumer advocates have taken multiple steps to try and mitigate this problem.  Prior IRS revenue procedures 2015-57, 2017-24, and 2018-39 provided the same relief that 2020-11 provides, but they only applied to schools owned by Corinthian College, Inc. or American Career Institutes, Inc.  In other cases, lawyers have obtained private letter rulings from the IRS as part of a legal settlement with predatory schools.  A defrauded borrower not covered by prior IRS revenue procedures or a private letter ruling was still likely able to exclude all or substantially all of the discharged amounts based on the insolvency exclusion or disputing the debt.  However, many borrowers are not aware of how to file a form 8725 or 982 and it would be impossible for any direct assistance or advocacy group to identify or contact them all.  This leads to many former borrowers including the discharged debt as income.

Defrauded borrowers’ debts can often be in the tens of thousands of dollars before their loans are discharged.  If their taxable income increases by the amount of the discharged loan it is very likely their higher income will disqualify them from several tax deductions and credits, raising their tax bill by thousands of dollars.  For the millions of Americans who live paycheck to paycheck, an unexpected (and incorrect) tax bill of thousands of dollars can be devastating. 

IRS revenue procedure 2020-11, goes a long way to fixing this problem.  The IRS acknowledged that “most…student loan borrowers [who have debts discharged because of school misconduct or school closure] would be able to exclude from gross income all or substantially all of the discharged amount[.]” They also agree that determining which exclusions to use “would impose a compliance burden on taxpayers, as well as… the IRS, that is excessive in relation to the amount of taxable income that would result.” 

The revenue procedure is retroactive.  It is effective for federal student loans discharged on or after January 1, 2016.  If a taxpayer had student loan debt discharged due to school misconduct after January 1, 2016, and paid taxes on the discharged amount, they should be able to file an amended return to get their money back.  The IRS also announced that taxpayers will not have to amend prior year returns to reduce education tax credits they took in the past.  It should be noted that VITA tax sites will not be able to complete these amended returns as the forms required are outside of their scope of services.

We applaud the IRS for this change.  It drastically reduces risk that borrowers will overpay their taxes and at the same time reducing administrative costs to the government.

Comments

  1. Bob Kamman says

    Why do they call it a Rev Proc when there is very little procedure? Specifically, what does the IRS suggest taxpayers do if they think they benefit from this pronouncement because a 1099-C was issued to them despite the dispensation for schools willing to identify themselves as bad actors?

    Last night, to answer a question on a practitioner message board about a student loan 1099-C, I refreshed my memory with Keith Fogg’s July 11, 2018 post at

    https://procedurallytaxing.com/what-to-do-if-you-receive-a-form-1099-c-with-which-you-disagree/

    …which has a link to a pdf guide from the Legal Services Center, dealing with this question. The proposed solution is to file Form 8275 to disclose the reason for the omission from income. Suggested text is included.

    There are other situations where a 1099 amount does not have to be included in income. For example, see long-term care insurance payments on 1099-LTC, and life insurance lifetime payments on the new 1099-LS. Taxpayers have been trained that if something is reported to IRS, it should appear on their returns also. But how is it shown, if it is not taxable? Some day perhaps Rev Procs will be required to answer questions like that.

  2. Please tell me …How do I go about requesting my 2017 tax refund back the DOE, since I was granted student loan forgiveness due to the fraudulent activity@everest college? I’m having severe hardship now, but this is partially the reason I can’t get caught up. Thank you for your assistance!

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