Student loan forgiveness and repayment programs.

• Author: Schneider, Kent N.

EXECUTIVE SUMMARY

* The government and private entities offer various forms of relief from student loan debt, including programs that provide either debt repayment or forgiveness.

* In general, when a lender forgives or discharges a borrower's debt, including student loan debt, the amount of the cancelled debt is income that is taxable to the borrower. An exception to this rule is available to former students who perform public service in exchange for loan forgiveness.

* In order to qualify for the exemption from income inclusion for student loan debt forgiveness, the lender must be a qualifying lender and the lender must forgive or discharge the loan amount;, the exemption does not apply if a third party repays the loan amount.

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Due to rising tuition costs, the number and size of student loans have increased dramatically in recent years. Once the exclusive domain of college financial aid offices and hometown banks, education loans are now the subject of cable TV commercials and e-mail solicitations from major credit card companies. Indeed, for many, student loans are readily available. The problem starts after graduation when loan payments begin. For those students who pursue careers in the high-demand/low-reward public service arena, the repayment problem is especially acute.

Over the past 15 years, Congress has attempted to alleviate this problem by various means, including extending the repayment period for student loans, creating debt forgiveness and debt repayment programs, and even providing a tax deduction for the payment of student loan interest. (1) Private-sector employers in high-demand professions have joined in, offering their own student loan repayment plans as a recruitment tool.

As a result, recent graduates face a bewildering array of options for dealing with the substantial student debt that they have accumulated, often over the better part of a decade. Those who successfully negotiate this maze and find a repayment plan or debt forgiveness plan that meets their needs are often surprised by the income tax consequences of their decisions. To provide a roadmap for these students and their tax advisers, this article describes the more prevalent loan forgiveness and loan repayment programs, along with the associated tax consequences.

Overview of Student Loan Forgiveness and Reimbursement Plans

Student loan forgiveness plans fall into three categories. Most important are the federal loan forgiveness provisions connected with the extended loan repayment plans elected by qualifying borrowers who are incapable of paying off their education loans over the typical 10-year period. In addition, specialized loan forgiveness and loan repayment programs are available for borrowers who work for certain employers (e.g., the Peace Corps, the military, school districts with a high proportion of low-income or special needs students). Finally, hardship rules provide debt relief in extreme cases, such as the borrower's death or disability.

Loan Forgiveness Associated with Extended Repayment Plans

Student loan repayment schedules typically provide for monthly payments over a 10-year period. For most, the required monthly payments are manageable. But for those who accumulated debt over a five- to eight-year period while acquiring advanced degrees, the burden often is crushing. (2) To provide relief, Congress added the option of repaying student loans made by, or guaranteed by, the federal government over a maximum of 25 years. (3) Any unpaid balance at the end of the 25-year repayment period is canceled. (4)

More recently, Congress enacted the College Cost Reduction and Access Act of 2007, which includes a provision designed to encourage recent graduates to enter public service. (5) Under this provision, the unpaid balance of a student loan will be discharged after 10 years if the borrower is employed full-time in a public service job. For purposes of this rule, "public service jobs" are very broadly defined to include emergency management, military service, public safety, law enforcement, public health, public education, social work in a public agency, public interest law services, public child care, public service for individuals with disabilities and for the elderly, public and school-based libraries, and employment at tax-exempt Sec. 501(c)(3) organizations. (6)

Other Loan Forgiveness and Repayment Programs

In addition to the 25-year and 10-year loan forgiveness plans described above, numerous other programs encourage entry into high-demand fields by offering loan forgiveness or reimbursement for student loan payments. Some of the more prominent areas include military service, medical professions, employment at federal agencies, teaching, and volunteer service. The relief provided by these programs ranges from a modest debt forgiveness of $4,725 for a year of service in AmeriCorps or...