The IRS announced an expansion of relief to additional individuals who borrowed funds to attend school and later had that debt cancelled in Revenue Procedure 2020-11.[1]

The IRS had previously granted relief to those who attended schools owned by Corinthian College, Inc. (CCI) or American Career Institutes, Inc. (ACI) and had their loans discharged by the Department of Education under the “Closed School” or “Defense to Repayment” programs. This relief was limited to those who had attended schools owned by CCI or ACI.[2]

The Revenue Procedure describes this prior relief as follows:

.04 Rev. Proc. 2018-39 provides relief for taxpayers who took out private student loans to finance attendance at a school owned by CCI or ACI and whose loans were discharged based on a settlement of a legal cause of action resolving various allegations of unlawful business practices, including unfair, deceptive, and abusive acts and practices against CCI, ACI, and certain private lenders.

.05 Rev. Proc. 2015-57, Rev. Proc. 2017-24, and Rev. Proc. 2018-39 provide the following relief: (1) the Internal Revenue Service (IRS) will not assert that these taxpayers must recognize gross income resulting from the discharge of these Federal and private student loans; (2) the IRS will not assert that these taxpayers must increase their gross income by the amount of certain tax credits or deductions related to the discharged Federal and private student loans; and (3) the IRS will not assert that the creditors of these discharged loans must file information returns and furnish payee statements under section 6050P of the Code as a result of discharging these Federal and private student loans.[3]

Since that relief was issued, other students who attended schools not owned by either CCI or ACI have had their loans discharged under similar circumstances or under legal settlements relating to a school’s business practices. The IRS has now decided to extend relief to more than just those students that attended other institutions:

.08 The Treasury Department and the IRS have determined that it is appropriate to extend the relief provided in Rev. Proc. 2015-57, Rev. Proc. 2017-24, and Rev. Proc. 2018-39 to taxpayers who took out Federal and private student loans to finance attendance at nonprofit or other for-profit schools not owned by CCI or ACI where the Federal loans are discharged by ED under the Closed School or Defense to Repayment discharge process, or where the private loans are discharged based on a settlement of a legal cause of action against nonprofit or other for-profit schools and certain private lenders. As in Rev. Proc. 2015-57, Rev. Proc. 2017-24, and Rev. Proc. 2018-39, the Treasury Department and the IRS believe that most Federal and private student loan borrowers would be able to exclude from gross income all or substantially all of the discharged amounts based on the insolvency exclusion under section 108(a)(1)(B) of the Code; fraudulent or material misrepresentations made by such nonprofit or for-profit schools or certain private lenders to the students; or other tax law authority. However, determining whether one or more of these exclusions is available to each affected borrower would require a fact intensive analysis of the particular borrower's situation to determine the extent to which the discharged amount is eligible for exclusion under each of the potentially available exceptions. The Treasury Department and the IRS are concerned that such an analysis would impose a compliance burden on taxpayers, as well as an administrative burden on the IRS, that is excessive in relation to the amount of taxable income that would result. Accordingly, the IRS will not assert that a taxpayer within the scope of the safe harbor in this revenue procedure recognizes gross income as a result of the discharge.[4]

Section 3 of the Revenue Ruling provides information on the scope of the relief offered:

.01 The treatment provided in section 4 of this revenue procedure applies to any taxpayer who took out Federal or private student loans to finance attendance at a nonprofit or for-profit school described in section 3.02 of this revenue procedure and (a) whose Federal loans are discharged by ED based on the Closed School or Defense to Repayment discharge process, or (b) whose private loans are discharged based on a settlement of a legal cause of action resolving various allegations of unlawful business practices, including unfair, deceptive, and abusive acts and practices against a nonprofit or for-profit school or private lenders that made student loans to finance attendance at these schools. This revenue procedure also applies to any applicable entity, as defined by section 6050P of the Code and the regulations thereunder, that discharges these loans.

.02 Section 3.01 of this revenue procedure applies to nonprofit schools that meet the definition of an “institution of higher education” under 20 U.S.C. § 1001(a) or (b), or for-profit schools that meet the definition of a “proprietary institution of higher education” under 20 U.S.C. § 1002(b).[5]

Note that the second category in Section 3.01 expands relief to individuals that had their debts discharged due to a legal settlement involving allegations of unlawful business practices—so the relief goes beyond just those who had debt discharged under the Department of Education programs covered by the earlier Revenue Procedures.

Safe Harbors

Of course, taxpayers may be concerned about whether the IRS will agree that they are eligible for this relief under the provisions of Section 3 and their exact circumstances. The Revenue Procedure provides for three safe harbors under which taxpayers will automatically qualify.[6]

Borrowers Participating in the Closed School Discharge Process

The first safe harbor covers borrowers that are participating in the Department of Education’s closed school discharge process. The ruling provides the following guidance on when a borrower will meet this safe harbor:

The Closed School discharge process allows ED to discharge a Federal student loan obtained by a student, or by a parent on behalf of a student, who was attending a school at the time it closed or who withdrew from the school within a certain period prior to the closing date. The HEA provides statutory exclusions from gross income for Federal student loans discharged under the Closed School discharge process.

A taxpayer whose Federal student loan is discharged under the Closed School discharge process will not recognize gross income as a result of the discharge, and the taxpayer should not report the amount of the discharged loan in gross income on his or her Federal income tax return.[7]

This was one of the programs for which relief was given for those attending schools owned by CCI or ACI in the older Revenue Procedures.

Borrowers Participating in the Defense to Repayment Discharge Process

The IRS also has extended relief outside of the schools owned by CCI and ACI for those participating in the Defense to Repayment discharge process. The requirements to meet this safe harbor are detailed as follows in the ruling:

The Defense to Repayment process allows ED to discharge a Federal Direct Loan obtained by a student, or by a parent on behalf of a student, if the borrower establishes, as a defense against repayment, that a school's actions would give rise to a cause of action against the school under applicable state law. Most of these borrowers would be able to exclude from gross income the discharged amounts based on the insolvency exclusion, fraudulent or material misrepresentations, or other tax law authority.

A taxpayer whose Federal student loan is discharged under the Defense to Repayment discharge process will not recognize gross income as a result of the discharge, and the taxpayer should not report the amount of the discharged loan in gross income on his or her Federal income tax return.[8]

Like the first safe harbor, this is merely an expansion of relief offered under the prior Revenue Procedures to students aside from those who had attended ACI or CCI owned schools.

Borrowers Participating in Legal Settlement Discharge Actions

The final category is the “legal settlement discharge” category. The IRS describes those qualifying for this safe harbor as follows:

Federal and state governmental agencies have brought legal causes of action that have resulted in settlements resolving various allegations of unlawful business practices, including unfair, deceptive, and abusive acts and practices, against for-profit schools and certain private lenders that made student loans to finance attendance at these schools. Most of these borrowers would be able to exclude amounts discharged as a result of these settlements from gross income based on the insolvency exclusion, fraudulent or material misrepresentations, or other tax law authority.

A taxpayer whose private student loan is discharged based on a settlement of a legal cause of action resolving various allegations of unlawful business practices against nonprofit or for-profit schools or private lenders that made student loans to finance attendance at these schools will not recognize gross income as a result of the discharge, and the taxpayer should not report the amount of the discharged loan in gross income on his or her Federal income tax return.[9]

Unfortunately, it’s not clear from this description found in the Revenue Ruling if the legal cause of action must be initiated by a governmental agency. The first paragraph only discusses such actions, but the second paragraph and the general rule found in Section 3 make no mention of government only actions.

Waiver of Recapture of Prior Tax Credits or Deductions

The ruling also provides that the IRS will not attempt to force covered borrowers to increase their taxes in the year of discharge or a prior year to recapture various education benefits. The ruling provides:

The IRS will not assert that a taxpayer within the scope of this revenue procedure must increase his or her taxes owed in the year of a discharge, or in a prior year, as a result of a discharge described in section 4.01 of this revenue procedure, if in a prior taxable year he or she received an education tax credit under section 25A of the Code attributable to payments made with proceeds of the discharged loan. In addition, the IRS also will not assert that a taxpayer within the scope of this revenue procedure must increase his or her gross income in the year of the discharge as a result of a discharge described in section 4.01 of this revenue procedure, if in a prior taxable year he or she took a deduction under section 221 of the Code attributable to interest paid on a discharged loan or a deduction in a prior taxable year under section 222 of the Code attributable to payments of qualified tuition and related expenses made with proceeds of the discharged loan.[10]

Form 1099-C Issues

Finally, the IRS provides that lenders who have discharged such a debt will not be penalized for failing to file a Form 1099-C and, in fact, should refrain from filing the document in cases covered by this ruling:

The IRS will not assert that a creditor that is an applicable entity, as defined by section 6050P of the Code and the regulations thereunder, must file information returns and furnish payee statements pursuant to section 6050P of the Code for the discharge of any indebtedness within the scope of this revenue procedure. The filing of such information returns with the IRS could result in the issuance of underreporter notices to taxpayers and the furnishing of such payee statements to taxpayers could cause confusion.[11]

Retroactive Effective Date

The relief provided by this Revenue Ruling is generally retroactive all the way back to tax year 2016. As the ruling provides:

This revenue procedure is effective for Federal student loans discharged by ED in taxable years beginning on or after January 1, 2016, under the Closed School or Defense to Repayment discharge process, and for private student loans discharged in taxable years beginning on or after January 1, 2016, based on a settlement of a legal cause of action resolving various allegations of unlawful business practices, including unfair, deceptive, and abusive acts and practices against the nonprofit or for-profit schools or certain private lenders. Taxpayers to whom this revenue procedure applies may claim a credit or refund for an overpayment of tax for taxable years for which the period of limitations under section 6511 of the Code has not expired.[12]

Taxpayers who have included such a discharge in income in a prior year should consider filing a claim for refund before the statute of limitation for claiming the refund expires—as it will come mid-April for those who filed their 2016 individual return without going on extension and have paid tax on debt discharge in that year.

[1] Revenue Procedure 2020-11, January 15, 2020, https://www.irs.gov/pub/irs-drop/rp-20-11.pdf (retrieved January 16, 2020)

[2] Revenue Procedure 2020-11, Section 2

[3] Revenue Procedure 2020-11, Section 2

[4] Revenue Procedure 2020-11, Section 2

[5] Revenue Procedure 2020-11, Section 3

[6] Revenue Procedure 2020-11, Section 4.01

[7] Revenue Procedure 2020-11, Section 4.01(a)

[8] Revenue Procedure 2020-11, Section 4.01(b)

[9] Revenue Procedure 2020-11, Section 4.01(c)

[10] Revenue Procedure 2020-11, Section 4.02

[11] Revenue Procedure 2020-11, Section 4.03

[12] Revenue Procedure 2020-11, Section 6