Student Loan Debt Haunts Parents After Son's Death

The tragic death of a Maine man in 2012 has prompted federal legislators to introduce a bill that seeks to eliminate tax penalties for families whose student loans are forgiven after the death or permanent disability of their child.

Keegan Brennen died at the age of 22 from a brain aneurysm just six months after graduating from college. His parents, Donald and Nora, were successful in having his $78,000 in student loan debt forgiven, but were hit with $30,000 in taxes owed to the state and federal government. That’s because the IRS considers the forgiven loan amount as taxable income.

That could soon change, however, if Sen. Angus King (I-Maine) has his way. King introduced on April 14 a bill co-sponsored by Sen. Rob Portman (R-Ohio) and Sen. Chris Coons (D-Delaware) that would eliminate this tax, which the legislators say “simply replaces one financial burden with another and serves no public policy purpose.”

The bill also would allow a parent whose child develops a total and permanent disability to qualify for student loan discharge. While the federal government forgives certain federal student loans in the case of the death or disability of the borrower, the IRS still levies an income tax on this cancelled debt which can result in tens of thousands of dollars in immediate tax liability.

While the IRS considers most types of cancelled debt as taxable income (lenders must report cancelled debts of $600 or more to the IRS on a 1099-C form), not all cancelled student loan debt is taxable. There is, however, no tax break for student loan debt that has been cancelled due to death (if someone besides the deceased was also a borrower) or disability, despite the fact that borrowers who qualify for cancellation are considered totally and permanently disabled, and may never work again. In fact, the Department of the Treasury has specifically stated that student loans cancelled due to the Death and Disability Discharge (Section 437(a) of the Higher Education Act of 1965) are taxable.

“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,” Sen. King said in a statement on his Senate website. “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.”

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The bill comes at a time of heightened awareness around student loan debt.

In fact, the Obama administration announced in mid-April a plan to forgive $7.7 billion in federal student loans held by an estimated 387,000 permanently disabled Americans, of which roughly half (179,000) are in default.

While the administration tried to streamline the discharge of student loans for the permanently disabled four years ago, few eligible borrowers took advantage. Now, the Department of Education is starting to identify and reach out to eligible borrowers to help them take the necessary steps to discharge their loans.

As King’s legislation proposal wends its way through Congress, it’s important to remember that keeping current with student loan payments is essential because defaulting on a loan seriously damages your credit score. And because student loans are rarely discharged in bankruptcy, the debt can beat down on you for decades. (You can see how your student loans are currently impacting your credit scores for free on Credit.com.)

There are some options for people who are behind on payments to get back on track, though, even if forgiveness isn’t an option. To get out of default, you can combine eligible loans with a federal Direct Consolidation Loan, or you can go through the government’s default rehabilitation program. If you make nine consecutive on-time payments (they can be extremely low), your account goes back into good standing and the default is removed from your credit report.