When a student loan borrower becomes totally and permanently disabled they can apply to have their student loans “discharged” (forgiven) through the Total Permanent Disability Discharge program (TPD Discharge: learn more here). The survivors of a borrower who dies can also apply to have the deceased’s loans discharged. This includes Parent PLUS loan borrowers whose child has died. Up until this year that loan forgiveness, while a relief for hundreds of thousands of borrowers and their families, could bring about a large tax liability. Because the IRS considers any amount of forgiven debt over $600 taxable as income.
The tax bill passed in December 2017 put a temporary stop to that:
Loans fully discharged between 2018-2025 won’t be subject to taxation as income so there is no tax liability.
What does “fully discharged” mean?
To be considered “totally and permanently disabled” a borrower must have a disability that has lasted, or will last, for at least five years, and can no longer engage in substantial gainful activity. Typically, that means they have to meet income guidelines during the waiting period. When a borrower’s application for discharge is accepted all collection activity ceases, even if the loans are defaulted. The borrower enters into a three-year waiting period during which time they are required to supply documentation of any earned income each year. If after three years they have not earned too much income their student loans will be forgiven, or fully discharged.
Different rules for Veterans and Death Discharge
If a Veteran is determined unemployable and 100% disabled due to a service-related injury his or her student loans will be fully discharged upon acceptance of the TPD Discharge application. All collection activity will cease and the loan holder will be required to return any payments made by the Veteran since the date they were determined disabled and unemployable by the Veteran’s Administration.
Those who apply for a death discharge are not subject to the waiting period. They can expect the loans to be discharged upon acceptance of the application.
Tax Liability depends on when the loans are discharged
Borrowers whose loans were discharged in 2017 or earlier will still have to deal with the tax consequences of discharge. However, there are certain exceptions that may apply, like insolvency – where a borrower’s debts exceed their assets. Borrowers who receive a 1099-C should be sure to seek competent tax advice.
If you think you may be eligible for TPD Discharge, but aren’t sure, LSS Financial Counseling can help. We have Certified Student Loan Repayment Counselors to help you explore your student loan repayment options for free. Call 1-888-577-2227 today to schedule an appointment.
Author Shannon Doyle is a Certified Financial Counselor and she specializes in Student Loan, Budget, and Debt Counseling.
Note: This is for informational purposes only; for specific tax advice, consult a reputable tax professional.