Forgiven but Not Forgotten: Taxation of Forgiven Student Loans Under the Income-Based-Repayment Plan

AuthorJonathan M. Layman
PositionWill receive his J.D. from Capital University Law School in May 2011

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Most agree that there are few things as valuable in life as a quality college education.1A strong education expands minds and opens doors to a wide variety of career options not available to those lacking a degree.2

However, a quality college education is also extremely expensive and frequently results in large quantities of student loan debt that may stay with the student throughout much of his or her life.3

In order to encourage higher education, the Federal Government has created several loan programs to help students pay the high cost of college and graduate school.4To further assist students participating in these student loan programs, the Federal Government established loan forgiveness programs under which there is no tax liability incurred as a

Copyright © 2011, Jonathan M. Layman.

* Jonathan Layman will receive his J.D. from Capital University Law School in May 2011. He received his B.A. in History from The Ohio State University in 2005. He would like to thank the many colleagues, family, and friends who offered their assistance. He would like to especially thank his advisor Geoffrey Fallon for his outstanding insight and suggestions.

1See Uri Dothan & Joseph Williams, Education as an Option, 54 J. BUS. 117, 117 (1981); see also Catherine E. Ross & Marieke Van Willigen, Education and the Subjective Quality of Life, 38 J. HEALTH & SOC. BEHAV. 275 (1997) (discussing a social study on how education affects a person‘s well-being both in regards to relationships and work environment).

2See T. Brooke Benjamin, Public Perceptions of Higher Education, 19 OXFORD REV.

EDUC. 47, 49 (1993); Ross, supra note 1, at 276–77.
3See Jennifer Ma & Sandy Baum, Trends in College Pricing, TRENDS IN HIGHER EDUC.

SERIES (College Board, Wash., D.C.), 2008, at 2, available at; Kathleen Payea & Sandy Baum, Trends in Student Aid, TRENDS IN HIGHER EDUC. (College Board, Wash., D.C.), 2008, at 2, available at

4See 34 C.F.R. § 682.100 (2009).

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consequence of the cancellation of indebtedness income resulting from the forgiveness.5

There is an anomaly, however, in Congress‘s approach to student loans and cancellation of indebtedness income. In 2009, a new income-based-repayment plan became available to persons with federally backed student loan debt.6Unfortunately, Congress failed to implement any new provisions in the Internal Revenue Code to prevent loans forgiven under the new income-based-repayment plan from being taxed as cancellation of indebtedness income when the taxpayer completes the plan and is absolved of any remaining debt.7This omission appears to be at odds with the goal of making higher education affordable for students who might otherwise be unable to afford such an education.

This comment provides a comprehensive review of the law of cancellation of indebtedness income and also describes several Federal Student Loan programs and how such programs address the cancellation of indebtedness issue. Using this background, the comment discusses the apparent inconsistency in the law that exempts cancellation of indebtedness income under some student loan programs but not others. Finally, the comment argues for a change in the law to exempt cancellation of indebtedness income from loans forgiven under the income-based-repayment plan. The author hopes that this comment will provide the reader with a greater understanding of the tax consequences of forgiven debt as well as an appreciation of the need to implement new legislation protecting taxpayers who participate in the income-based-repayment plan from potentially massive tax liability in a single year.


A. The Price of Education

The cost of college education is high and has risen continuously for decades.8The average price for in-state tuition, room, and board at public universities in the United States for the school year beginning in 2008 was $14,333.9The average cost of tuition, room, and board for out-of-state

5See, e.g., 20 U.S.C. § 1078 (2006).

6Id. § 1098(d)(8) (Supp. 2009).

7I.R.C. § 108(f)(1) (2009).

8See Ma & Baum, supra note 3, for a comprehensive report on college pricing in the United States.

9Id. at 2.

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students was much higher at $25,200.10In the same year, students at private universities paid yet a higher average of $34,123.11Perhaps even more alarming than the above average prices is the fact that these already high costs have outpaced inflation for many years and are currently increasing at annual rates of 5.7%, 5.2%, and 5.6% for in-state, out-of-state, and private schools respectively.12

Clearly, it is not reasonable to expect that most students and their families will be able to pay these costs up front without some kind of financial assistance or loans. In spite of the availability of a wide range of grants and scholarships, many students are forced to turn to student loans for a large portion of their educational funding.13In the school year ending in 2007, 60% of students graduating with a bachelor‘s degree had some amount of student loan debt.14Of those students who had at least some debt upon graduation, the average student graduated with $22,700 in student loan debt.15

Graduates of law schools and other post-graduate programs may incur an even greater burden. According to the American Bar Association, the average student of a public law school in 2008 graduated having borrowed $59,324.16Law students graduating from private law schools borrowed an average of $91,506.17These numbers represent increases of $12,825 and $21,359 for state and private law schools respectively since 2002.18

Much of this borrowing is directly or indirectly financed or guaranteed by the Federal Government.19For the school year ending in 2008, the total amount of federal student lending from all federal programs combined amounted to the staggering sum of $66.8 billion.20Compensating for inflation, this amount represented a 70% increase over just the past ten




13See Payea & Baum, supra note 3, for a comprehensive report on the state of student aid in the United States.

14Id. at 3.

15Id. at 2.

16Average Amount Borrowed for Law School, AMERICAN BAR ASSOCIATION, http://ww (last visited Nov. 30, 2010).



19Payea & Baum, supra note 3, at 2.

20Id. at 6.

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years.21Obviously, student loan debt is a serious financial issue for students and their families and will continue to be an issue many years after graduation.

B. Federally Backed Student Loans

1. Types of Federal Student Loans

In order to avoid cancellation of indebtedness income from a forgiven student loan, the taxpayer must satisfy two key requirements. First, the terms of the forgiveness must meet the requirements of I.R.C. § 108(f).22

Second, the forgiven loan must have been a federally backed student loan.23There are several different types of federally backed student loans available to students including Perkins Loans,24Stafford Loans, and PLUS Loans.25These programs are described briefly below.

Perkins Loans are intended for ―financially needy‖ students who need help financing their higher education.26Eligible undergraduate students may borrow up to $4,000 per year but may not exceed a total of $20,000 over the course of their program of study.27Graduate students may borrow up to $6,000 per year but may not exceed a total of $40,000.28Students enrolled in any other type of program, such as those enrolled in trade schools or nontraditional programs, may not exceed a total of $8,000.29

The Stafford Loan program is a general federally backed student loan program intended for all undergraduate, graduate, and professional students.30Undergraduate students may not exceed an aggregate of $46,000 in federal Stafford Loans over the course of their program.31

Graduate students are permitted to borrow up to an aggregate of $138,500.32


22I.R.C. § 108(f) (2009).


2434 C.F.R. § 674.1 (2006).

25Id. § 682.100 (2009).

26Id. § 674.1(a) (2006).

27Id. § 674.12.



30Id. § 682.100(a)(1) (2009).

31Id. § 682.204(e).


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The intent of the PLUS Loan program is to promote private lending to the parents of undergraduate students.33A 2006 amendment to this program permits graduate students to obtain PLUS Loans independent of their parents.34There is no mandatory cap on the amount a student can borrow under the PLUS program other than the requirement that ―[t]he total amount of all PLUS program loans that a parent or student may borrow for any academic year of study may not exceed the student‘s cost of education minus other estimated financial assistance for that student.‖35

In other words, a student may only borrow as much as is needed for his or her legitimate educational expenses. As a clear example of the complexity of the system of federally backed student loan programs, I.R.C. § 108(f), which is discussed more fully below, applies to PLUS Loans made directly to graduate students but not to PLUS Loans made to parents of college students.36

Federally backed student loans are further subdivided into loans made directly by the Federal Government and loans made by other entities but guaranteed by the Federal Government under the Federal Family Education Loan (FFEL) program.37Loans made under the FFEL program are...

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