Bipartisan Bill Ends Tax Penalty on Student Loan Forgiveness for Americans with Permanent Disabilities and Families Suffering from the Death of a Child

Press Release

U.S. Senators Chris Coons (D-Del.), Angus King (I-Maine), and Rob Portman (R-Ohio) today introduced legislation to eliminate a tax penalty levied on student loans forgiven for families after the death of their child and Americans who develop permanent disabilities. While the federal government forgives certain federal student loans in the case of the death or disability of the borrower, the IRS treats this cancelled debt as income, which can result in tens of thousands of dollars in immediate tax liability. The Stop Taxing Death and Disability Act would eliminate this unfair tax, which simply replaces one financial burden with another and serves no public policy purpose. The tax on discharged loans is not only an unnecessary tax, but it also prevents the Department of Education from streamlining the loan forgiveness process.

On Tuesday, the Department of Education announced that it has identified 387,000 totally and permanently disabled Americans who were eligible for, but had not received, loan forgiveness. The Department of Education requires these totally and permanently disabled borrowers to apply for discharge to ensure they are aware of the potential tax consequences associated with loan forgiveness. If the tax is eliminated, these loans could be discharged immediately.

The Senators' interest in this issue was spurred by the outreach from constituents in Delaware, Maine, and Ohio, including a Maine couple whose son passed away unexpectedly from a brain aneurysm in 2012. The young man had recently graduated from college, using federal and private student loans to finance his education. Although the federal government and private lender forgave the outstanding loan balances, the parents were then presented with a tax bill of over $24,000 from the IRS. This family has since had to dip into their 401(k) to pay the bill and are now sending over $400 per month in tax payments to the agency.

"Taxing Americans who are grieving the death of a child or adjusting to a life-changing disability is simply unconscionable," said Senator Coons. "We forgive these student loans because that's the right thing to do as a country. Requiring these Americans to pay a surprise tax is counter to the intent of forgiving the loans in the first place and serves no public policy purpose whatsoever. Today my colleagues and I are offering a simple bipartisan bill that eliminates this unfair tax, and I urge Congress to pass our bill immediately."

"To think that a person who becomes disabled or a family that loses a child would be forced to reach into their pocket to pay the IRS taxes on student loans that have already been forgiven is just wrong," Senator King said. "It's unfair and it only serves to heap totally unnecessary financial hardship on folks when they're already trying to cope with personal tragedy. This fix is not only common sense, it's just the right thing to do and I hope we can act on this bill soon so that no one else in Maine or across the country has to be the victim of this senseless policy."

"Families grieving the loss or permanent disability of a child did nothing wrong, and they should not be punished by the federal government with a massive tax bill," said Senator Portman. "The same tragic reason they cannot pay back their student loans is the reason that they cannot afford an enormous tax increase so contrary to the purposes of our student loan system. Our bipartisan bill will fix this problem once and for all."

The federal government authorizes the forgiveness of certain federal loans in the case of the death or total and permanent disability of the borrower, including:

Student loan discharge for death. Congress has acknowledged the tragic circumstances of when a parent loses a child by authorizing the Department of Education to forgive outstanding federal student loans that a parent borrowed on behalf of their child prior to their child's death. Many private lenders also discharge student loans that are co-signed by a parent if their child dies.

Student loan discharge for disability. Each year, thousands of Americans, including veterans, develop disabilities or chronic health conditions so severe that they are determined by the federal government to be totally and permanently disabled. In recognition of the tremendous burden of their disabilities, Congress authorized the Department of Education to forgive outstanding federal student loans held by these Americans. Many private lenders also discharge student loans as a result of total and permanent disability.
Despite these provisions, individuals who suffer great personal loss or severe injury are often shocked to learn that the IRS requires them to pay income tax on the amount of student loans forgiven by the federal government and private lenders. A one-time discharge can result in tens of thousands of dollars in immediate tax liability.

The Stop Taxing Death and Disability Act:

Exempts from income tax federal and private student loans that are discharged due to the death of a child or total and permanent disability. Congress already exempts certain discharged federal student loans from income taxes. Under Section 108(f) of the Internal Revenue Code, public sector employees, including teachers, public defenders and librarians, who meet length of service requirements, are exempt from paying income tax on discharged loans. The Higher Education Act also provides for the tax-exempt forgiveness of student loans due to the closure of a borrower's school. This bill simply adds federal and private student loan discharges as a result of death or total and permanent disability to the existing list of tax-exempt discharges.

Allows a parent whose child develops a total and permanent disability to qualify for student loan discharge. The bill resolves an inconsistency in statute by authorizing the Department of Education to discharge federal loans owed by a parent of a child who becomes totally and permanently disabled. Currently parents are allowed to discharge federal student loans if they develop a total and permanent disability, or if their child dies, but not if their child develops a total and permanent disability. The bill also exempts this new type of discharge from income tax.

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