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Student loan discharges may come with strings attached

On Behalf of | May 10, 2018 | Internal Revenue Service

For those considering bankruptcy because of the weight of student loan debts, they likely have unfortunately learned that discharging such debt is notoriously difficult. Essentially, bankruptcy debtors seeking to eliminate student loan debts must follow a rigid standard and show that their financial situation is going to persist and that they have made a good faith effort in paying them. However, courts have held this bar so high that few debtors actually qualify.

Nevertheless, the story of a disabled man who had $150,000 in student loans discharged brings some considerable concern to those who are looking to bankruptcy to eliminate these debts. After being allowed to wipe away the debt, the man was presented with a 1099-C, which is an IRS form indicating that forgiven debt is considered income under the U.S. Tax Code. After all of his deductions were considered, the man still was liable for $59,000 in tax debt.

This financial conundrum was very unfortunate, considering that the man was disabled and could not reasonably earn a living. Moreover, a large majority of debtors may not even realize that a tax bill comes with discharging student loan debt, even though it may be a fraction of the total loan debt eliminated.

This could generate another vicious collection cycle that may not be abated. The IRS will start with a letter indicating how much is owed, and then the collection process will likely escalate if regular payments are not made on such debt.

With that said, it is important for those considering bankruptcy to talk with an experienced tax attorney so that they understand all the financial implications involved.


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