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.