Cancellation of Student Debt

A loan taken by a student from an institution for the purpose of joining an educational institution is called student debt.  In order to avail the loan, an educational institution should be a regularly functioning institution.  It means that an educational institution must be one functioning in a fixed place, with fixed curriculum, and with regular students attending regularly[i].

Generally, if a person to whom a student owes a debt cancels that debt that canceled amount will be taxable as student’s income.  This income is termed as cancellation of indebtedness income.  However, in certain cases a discharged student debt will not be considered as income if the discharge was made under a specific provision.  For example, there can be a provision that require whole or part of a debt to be discharged if a person serves public offices for a certain period. But, exclusion from cancellation of indebtedness income will not apply to a debt discharged by a tax exempt institution and if the discharge was in relation to the work done for the grantor of the loan[ii].

There are certain governmental loan repayment programs that provide an alternative to repayment of loan by requiring the students to perform public services for a specified period.  For example, requirement of public services in areas where there is need for more medical professionals.  National Health Service Corps Loan Repayment Program[iii] and State Loan repayment programs[iv] under the Public Health Service Act provide for such loan repayments.  A student loan under these programs would be discharged only if the requirement of public service is satisfied[v].

Student loans entitled for exemption from including it as income on discharge of debts are loans granted by:

  • the U.S., or an agency of the U.S.,[vi]
  • a U.S. state, territory, or possession; the District of Columbia; or any political subdivision of the preceding units,[vii]
  • A tax exempt public benefit corporation which has power over public hospitals and the employees are public employees under law.[viii]
  • An educational institution, which is being funded on the basis of an agreement between any of the bodies mentioned above or under its own program intended to persuade students to serve the public.  Public service under this program by the student must have to be for government bodies or tax exempt organizations.[ix]

Certain refinancing loans are also excluded from cancellation of indebtedness income.  Discharge of a loan by an educational institution mentioned under 26 USCS § 170(b)(1)(A)(ii) and tax exempted organization[x] will not be included in income of a person if the earnings from that is used for refinancing another student loan.

[i] 26 USCS § 170(b)(1)(A)(ii)

[ii] 26 USCS § 108(f)(3)

[iii] 42 USCS § 254l-1

[iv] 42 USCS § 254q-1

[v] 26 USCS § 108(f)(4)

[vi] 26 USCS § 108(f)(2)(A)

[vii] 26 USCS § 108(f)(2)(B)

[viii] 26 USCS § 108(f)(2)(C)

[ix] 26 USCS § 108(f)(2)(D)

[x] 26 USCS § 501(c)(3)


Inside Cancellation of Student Debt