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Taxes on cancelled debt, part 2: Graduate and professional students

| Jul 24, 2016 | Tax Controversies

In the first part of this post, we began discussing how forgiveness of student loan debt can lead to a big tax bill for the debtor.

The case concerned the grief-stricken parents of a recent college graduate.
After their son died suddenly of a brain tumor, the lender forgave the students loans the parents had taken out. But years later, the parents got a bill from the IRS for income tax on cancelled debt.

In this part of the post, let’s look an example of how taxing cancelled student loan debt can affect graduate and professional school students. We will also take note of a proposal to change the law regarding taxing the parents of children who die.

Given the cost of higher education today, many undergraduates of course take on large debt loads. And many graduate and professional students take on even more.

Consider the case of a recent law school graduate who was featured in a New York Times article on the difficulties that many law grads have in finding suitable employment.

The lawyer featured in the Times had graduated from Valparaiso University School of Law in Indiana. Like many students in professional schools, his student loans were well into six figures (about $200,000).

The Times reported that if the lawyer is unable to repay the loan, the federal government would eventually make debt forgiveness available. But that would not be for 20 years – and it would in all likelihood be accompanied by a tax bill of perhaps $70,000 or more.

Our point is that the tax implications of cancelled debt greatly affect many graduate and professional students – even if the lender finally forgives the debt.

The emotions of taxing income from canceled student loan debt are heightened when parents are being billed for loans they took out for children who later died or became disabled.

Congress is considering changing the law so that this income will no longer be taxed.

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