Congressional lawmakers have urged Treasury to use its administrative authority to fix the problem, but the department is not taking action.
At a meeting Wednesday, Treasury officials informed Senate staffers that it will not issue guidance addressing the tax penalty for disabled borrowers, according to people in attendance who were not authorized to speak publicly. They said Treasury officials conceded that roughly two thirds of affected borrowers are insolvent, a designation that would allow Treasury to waive any taxes connected to discharged loans. Claiming insolvency, however, involves complex paperwork.
Treasury spokesman John Runyan would neither confirm nor deny what took place at the meeting. He said Congress could resolve the tax burden through legislation but has failed to act. There have been two separate pieces of legislation introduced in the Senate to help disabled borrowers with tax liabilities, but neither made it out of committee.
“Treasury shares concerns about the potential income tax consequences associated with student loan discharges for disabled borrowers,” Runyan said in an email. “Treasury continues to work with the Department of Education to evaluate possible alternatives that could address the situations faced by these borrowers.”
Education officials would only say they are working with Treasury, which declined to discuss the alternatives on the table.
The “tax bomb,” as some experts call it, gained attention this spring after the White House announced plans to forgive $7.7 billion in federal student loans held by nearly 400,000 permanently disabled people through a matching system. The Education Department and the Social Security Administration teamed to pinpoint borrowers receiving disability payments, under the specific designation of “Medical Improvement Not Expected,” which indicates they are eligible for the discharge.
Those identified received a letter from the government explaining the steps for loan cancellation and were not required to submit documentation of their eligibility, unlike disabled borrowers who apply for the discharge on their own. A vast majority of the people selected through the streamlined process are impoverished, living off of less than $16,000 a year — the federal poverty line for a family of two.
Eighty-four percent of the population identified by the Social Security Administration reported zero earnings in 2014, while the remainder pulled in an average of $8,000 a year. These borrowers, with no job prospects and minimal income, owe on average $18,000 in student loans. About half of them are in default, putting them at risk of having their Social Security disability benefits garnished.
A report issued this week by the Government Accountability Office was critical of the standard disability discharge system for jeopardizing the Social Security benefits borrowers receive. If people do not submit annual documentation verifying their income to the Education Department, their loans can be reinstated and garnished for failure to pay.
The Obama administration has made strides in providing debt relief to severely disabled people, although advocacy groups say more needs to be done, especially where taxes are concerned.
In a letter sent to Treasury in October, Sen. Elizabeth Warren (D-Mass.) warned of the financial quagmire facing severely disabled borrowers. Without debt relief, they are saddled with thousands of dollars in loans they struggle to repay. With debt relief, they are saddled with potentially thousands of dollars in taxes they also struggle to repay. And either situation leaves them vulnerable having Social Security benefits garnished.
“Treasury’s ongoing failure to provide guidance will impose an extraordinary compliance burden on Social Security beneficiaries who are totally and permanently disabled,” Warren wrote in the letter. “There is no justification for imposing demanding and unnecessary compliance burdens.”
It is not unprecedented for Treasury to issue guidance on the tax treatment of canceled debt. This summer, the department said real estate developers could exclude canceled debt tied to depreciable property from their gross income for tax purposes. Treasury also waived taxes for former Corinthian College students who received loan forgiveness.
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