Kim Thompson lives in New Jersey. She owed around $91,000 USD worth of student loan debt. In 2010, she was diagnosed with tumor. She took permanent leave from job and a disability pension due to her lengthy treatment. Because of her disability, she was able to get her student loan debt forgiveness. Her problems should have ended there. But it seem that her nightmare just started. Why?
The Federal Agency that issued the student loan to her reported the debt forgiveness to IRS as per current regulations. In eyes of IRS, Most student loan forgiven are an Income. It is called Cancellation of Debt Income or CODI for short. According to current laws, such debt forgiveness is a taxable income. All Lenders must submit a form called 1099-C Form when they cancel a debt of $600 or more. A 1099-C form was submitted for $91,000 forgiven to Kim Thompson due to her permanent and total disability.
Now Kim Thompson owes $26000 to IRS and an additional $5000 to New Jersey State. Tax break on CODI is given to certain professions or careers such as medical, teaching and law enforcement etc. Strangely tax break on CODI is not given to student loan debt forgiveness due to disability. they deserve it more than anybody else.
According to Finaid.org
Public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs and the National Health Service Corps Loan Repayment Program are not taxable. Loan discharges for closed schools, false certification, unpaid refunds, and death and disability are considered taxable income.
According to some legal experts, she had an option of declaring her self insolvent due to disability first via Form 982 and then seek discharge / cancellation of her student loan debt. The opinions are divided on the issue due to IRS’s Confusing guides. Relevant section is quoted below.
How to report the bankruptcy exclusion. To show that your debt was canceled in a bankruptcy case and is excluded from income, attach Form 982 to your federal income tax return and check the box on line 1a. Lines 1b through 1e do not apply to a cancellation that occurs in a title 11 bankruptcy case. Enter the total amount of debt canceled in your title 11 bankruptcy case on line 2. You must also reduce your tax attributes in Part II of Form 982 as explained under Reduction of Tax Attributes, later.
Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include:
- The entire amount of recourse debts,
- The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt, and
- The amount of nonrecourse debt in excess of the FMV of the property subject to the nonrecourse debt to the extent nonrecourse debt in excess of the FMV of the property subject to the debt is forgiven.
It seems that Kim Thompson fell victim to bad advice by her accountant who misread the above clauses. She is not the only one. Plenty of other people who are terminally ill and permanently disabled find themselves in same dilemma. They manage to get rid of their student loans by seeking forgiveness due to disability. They then have to face the IRS armed with 1099-C filed by the lenders. IRS is ruthless and if you don’t take necessary steps before hand they will come and get you even if you are disabled or dead.
Looking forward to your comments on this story. My deepest sympathies with Kim Thompson so are my reader’s.