Tax relief for federal student loan forgiveness

By John W. McKinley, CPA, CGMA, J.D., LL.M., and Eric Zilber

 Students were turned away from a Corinthian Colleges Inc. school in California in 2015 when the company shut down its remaining campuses.
Students were turned away from a Corinthian Colleges Inc. school in California in 2015 when the company shut down its remaining campuses. (Photo by Al Seib/Los Angeles Times via Getty Images)

A little over a year ago, the U.S. Department of Education settled and discharged various federal student loans for students who attended college at one of the more than 100 campuses owned by Corinthian Colleges Inc. (CCI), which, with its 24 subsidiaries, filed for Chapter 11 bankruptcy protection on May 4, 2015.

On Dec 3, 2015, the IRS issued Rev. Proc. 2015-57, in which it discusses the tax implications for the discharge of these loans to former CCI students under the Department of Education's "closed school" and "defense to repayment" processes. The revenue procedure explains that under the Higher Education Act of 1965 (HEA), taxpayers do not recognize income for loans discharged under the closed-school process.

On the other hand, the HEA does not provide a statutory exclusion from gross income for federal student loans discharged under the defense-to-repayment discharge process. Thus, under Sec. 61(a)(12), a taxpayer must include in gross income the amount of the loan discharge as cancellation-of-debt (COD) income. However, a taxpayer may be able to exclude amounts discharged under the defense-to-repayment process from gross income under another provision of the Code or the common law, such as the Sec. 108(a)(1)(B) insolvency exclusion or the common law disputed debt doctrine.

Because the majority of the Corinthian loans discharged under the defense-to-repayment process would be excludable from income under one of the statutory or common law exclusions, but determining which exception applies would require a fact-intensive, case-by-case analysis for each affected taxpayer, the IRS announced in the revenue procedure that it will not assert that a taxpayer within the revenue procedure's scope recognizes gross income as a result of the defense-to-repayment discharge process for a Corinthian loan. According to the IRS, it is taking this position to alleviate the compliance burden for the taxpayer and the administrative burden for the IRS in determining whether the taxpayer's loan should be excluded from gross income.

In addition, in Rev. Proc. 2015-57, the IRS states that under the tax benefit rule (Sec. 111), prior-year deductions and/or tax credits taken by a taxpayer within the scope of the revenue procedure are not added back to gross income and/or tax liability in the year that the federal student loan is discharged.

Practitioners may not have encountered the closed-school and defense-to-repayment provisions under U.S. Code Title 20 and Title 34 of the Code of Federal Regulations through which the CCI loans were discharged, but being aware of them may help clients with income from student loan forgiveness.

The closed-school discharge process cancels the "obligation to repay a Direct Loan," provided that "the borrower ... did not complete the program of study" because the borrower's school closed (34 C.F.R. §685.214(a)(1)). To qualify, the student must have been enrolled in the school at the time of its closure or have withdrawn from it within 120 days of the closure (34 C.F.R. §685.214(f)(1); Fact Sheet: Protecting Students From Abusive Career Colleges, available at Debt discharged under the defense-to-repayment process can be excluded from gross income for tax purposes only if the taxpayer meets the statutory or common law exceptions mentioned above. A defense-to-repayment discharge requires an "act or omission" that gives rise to a "cause of action against the school under applicable State law" (34 C.F.R. §685.206(c)(1)).

For purposes of Rev. Proc. 2015-57, the student loan forgiveness appears to apply only to certain federal student loans and not to private loans, which still need to meet a statutory or common law exception to be excluded from gross income.


Loans subject to the closed-school discharge include Federal Direct Stafford/Ford (subsidized and unsubsidized), Federal Direct PLUS, and Federal Direct Consolidation loans in which the borrower used the proceeds to attend a postsecondary institution (34 C.F.R. §685.100(a)). To qualify under the closed-school discharge process, besides attending the school when it closed or withdrawing from it within 120 days of its closure, students must have opted out of a "teach-out" program at another school and not have transferred their credits to another academic institution with a similar program (Section 487(f) of the HEA, as amended). A teach-out program is one where another higher education institution offers a degree completion program for institutions that cease, terminate, or have suspended "100% of either a Certificate or degree program before all students have completed their program of study" (Higher Learning Commission Policy No. FDCR.B.10.010).

If a student meets these requirements, then the discharge amount under 20 U.S.C. Section 1087(c)(4) is treated the same as loans discharged under 20 U.S.C. Section 1087ee(a)(5), which provides that a student's federal loan "shall not be considered income for purposes of [the Internal Revenue Code]" (HEA §465).


A defense to repayment allows the Department of Education to discharge a Federal Direct Loan or certain Federal Family Education Loans if the borrower establishes an act or omission that gives rise to a cause of action against the school under applicable state law (34 C.F.R. §685.206(c)(1)).

Since the inception of 34 C.F.R. §685.206(c) in 1994, no further regulatory guidance has been provided for what is meant by "act or omission" or "cause of action against the school under applicable State law." A notice of the results of the first meeting of the Borrower Defenses Regulations Negotiated Rulemaking Advisory Committee (60 Fed. Reg. 37768 (July 21, 1995)) stated that a "cause of action" must "directly [relate] to the loan or to the school's provision of educational services for which the loan was provided." Therefore, a cause of action does not apply to personal injury claims (i.e., tort actions) or civil rights violations.

Again, unlike the closed-school discharge process, the HEA does not provide a statutory exclusion from gross income for Federal Direct Loans and Federal Family Education Loans that are discharged under the defense-to-repayment process, although the IRS in Rev. Proc. 2015-57 did so with respect to CCI.


According to Rev. Proc. 2015-57, a taxpayer who attended CCI does not need to recapture any deductions and/or tax credits taken under Sec. 25A (American opportunity, Hope, and lifetime learning credits); Sec. 221 (student loan interest); or Sec. 222 (qualified tuition and related expenses deduction). However, unless the IRS were to grant similar special relief, the same cannot be said of other discharges under the closed-school discharge process. Nor would it be the case if a taxpayer's loan was forgiven under the defense-to-repayment process and the discharge was excluded from COD income under a statutory or common law provision.

With an increase in loan forgiveness programs, practitioners will need to be more aware of the ever-changing landscape of the inclusion or exclusion in gross income of student loan forgiveness.

John W. McKinley ( is a lecturer in accounting and taxation at Cornell University in Ithaca, N.Y., from which Eric Zilber (, a CPA candidate, graduated in December 2015 with a B.S. in applied economics and management, with concentrations in accounting and finance.

To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at or 919-402-4434.

Where to find June’s flipbook issue

The Journal of Accountancy is now completely digital. 





Leases standard: Tackling implementation — and beyond

The new accounting standard provides greater transparency but requires wide-ranging data gathering. Learn more by downloading this comprehensive report.