BEYOND BANKRUPTCY
The Tax and Estate Stage
Hopefully after 25 years of his
career and well into his 40’s or 50’s the
student loan debtor at least has a small
401K worth $60K. If the debt forgiven
together with any other liabilities that
year is less than $60K he already has
an asset (his retirement) that exceeds
his liabilities. Under this scenario, the
‘cancelled’ student debt stands to be
added to the debtor’s gross income.
“[T]o the extent a debtor’s
assets exceed liabilities after the
forgiveness, the forgiven debt is
taxable income.” (Abney at 689). This
is because ‘cancelled’ under the Higher
Education Act doesn’t mean ‘cancelled’
under the Internal Revenue Code
(“IRC”). Gross income under the IRC
specifically includes any “discharge of
indebtedness.” 26 U.S.C. §61(12). The
‘cancelled’ student loans are excluded
from gross income when the taxpayer
can show that he is insolvent. 26
U.S.C. §108 (a)(1)(C). Let’s put Abney
into a context to understand how easy
it is to get hit with this.
If there is a tax the debtor now
can either pay it in a lump sum just to
put an end to the student loan cycle
(likely from the 401K which incurs
another substantial tax), or he can try
entering a repayment plan now with the
IRS. And if he dies before finishing the
IRS repayment plan or can’t otherwise
declare bankruptcy on the tax under
11 U.S.C. §523(a)(1), then the unpaid
tax converts into a claim against the
debtor’s estate. In Illinois, for example,
debts owed to the United States rank
as a third class claim. 755 ILCS 5/1810. That means it gets paid right after
burying the dead debtor and a spousal
start an adversary proceeding in the
bankruptcy court to prove it. When he
establishes it the burden then shifts to
the Department of Education to rebut
it. In this case the debtor and the court
learned of the true harm an IBR inflicts
once the IBR was tested in a hearing
complete with cross-examination.
III.
6
CONSUMER BANKRUPTCY JOURNAL
Spring 2016
award if any.
IV.
Closing
The
Door
To A Fresh Start In
Bankruptcy
Student loans have their own
life cycle distinct from that of typical
loans. Student loan debtors as a group
of consumers were largely uninformed
about the consequences of the debt
before incurring it. And it’s easy to see
why. If they don’t really know the true
cost of the education or the full legal
consequences of the debt, then they
can’t really examine or negotiate the
commitment that they are making to
what turns out to be life-long debt.
Exempting student loans from
the Bankruptcy code frustrates its most
basic principle which is to provide the
“honest but unfortunate debtor … a
new opportunity in life and a clear field
for future effort unhampered by the
pressure and discouragement of preexisting debt.” In re Lobera, Bankr. 454
B.R. 824, 847 (N.M. 2011).
National Association of Consumer Bankruptcy Attorneys