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Effective for tax years beginning on or after January 1, 2015, the IRS has stated that it will not require taxpayers who took out federal student loans to finance attendance at a school owned by Corinthian Colleges, Inc. to recognize gross income as a result of the discharge of such loans under the Department of Education's "Defense to Repayment" discharge process. Rev. Proc. 2015-57.

Background

In April, the Department of Education (ED) fined Corinthian Colleges Inc., a large for-profit post-secondary education company, $30 million for misrepresenting job placement rates to current and prospective students within its Heald College system. The company subsequently began selling or closing the for-profit colleges it owned, and filed for bankruptcy in May.

The Department of Education has estimated that over 50,000 students who took out federal student loans to finance attendance at schools owned by Corinthian Colleges, Inc. may be eligible for discharges under the Closed School discharge process or, as a result of misrepresentations by the colleges, under the Defense to Repayment discharge process.

In general, under the Higher Education Act of 1965 (HEA), the Closed School discharge process allows the 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 before the closing date.

Under the HEA, the Defense to Repayment process requires the ED to discharge a Federal Direct Loan if a student loan 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.

The HEA provides statutory exclusions from gross income for federal student loans discharged under the Closed School discharge process. Accordingly, 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.

In contrast, the HEA does not provide a statutory exclusion from gross income for federal student loans discharged under the Defense to Repayment discharge process, but provisions of the Code or other tax law authorities may allow a taxpayer to exclude amounts discharged under the process. For example, Code Sec. 108(a)(1)(B) provides that a taxpayer may exclude from gross income a discharge of indebtedness that occurs when the taxpayer is insolvent (the "insolvency exclusion").

IRS Won't Require Affected Students to Include Discharged Loans in Income

According to the IRS, most borrowers whose Corinthian student loans are discharged under the Defense to Repayment discharge process would be able to exclude from gross income all or substantially all of the discharged amounts based on fraudulent misrepresentations made by the colleges to the students, the insolvency exclusion, or another tax law authority. However, the IRS noted, determining whether one or more of these exceptions 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.

Because 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, the IRS said that it will not require a taxpayer within the scope of Rev. Proc. 2015-57 to recognize gross income as a result of the Defense to Repayment discharge process.

The treatment provided Rev. Proc. 2015-57 applies to any taxpayer who took out federal student loans to finance attendance at a school owned by Corinthian Colleges, Inc. that are discharged under the Closed School discharge process or the Defense to Repayment discharge process.

In addition, the IRS said it will not require such taxpayers to increase his or her taxes owed in the year of a discharge, or in a prior year, as a result of either discharge process if in a prior year he or she received an education credit under Code Sec. 25A (Hope and Lifetime Learning Credits) attributable to payments made with proceeds of the discharged loan.

Finally, the IRS said it also will not require such taxpayers to increase his or her income in the year of the discharge if he or she took a deduction under Code Sec. 221 (interest on education loans) in a prior year attributable to interest paid on a discharged loan or a deduction under Code Sec. 222 (qualified tuition and related expenses) in a prior tax year attributable to payments of qualified tuition and related expenses made with proceeds of the discharged loan.

Rev. Proc. 2015-57 is effective for tax years beginning on or after January 1, 2015, for federal student loans discharged under the ED's Closed School and Defense to Repayment discharge processes. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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