Treasury Rebuffs Democratic Senators' Plan To Help Disabled Americans With Student Debt

The Obama administration won't shield impoverished debtors from paying income tax on forgiven loans.

WASHINGTON ― The Treasury Department has rejected a request by congressional Democrats to guarantee that impoverished, severely disabled Americans will not face a tax penalty for discharging student debt, according to an aide to a Democratic senator who had been advocating the measure.

Treasury representatives on Wednesday informed the staff of several Democratic senators that the department wouldn’t issue the “guidance” ― language clarifying its interpretation of tax law ― that Democrats requested, said the aide, who would only speak on condition of anonymity. Instead, Treasury officials discussed two alternative approaches that the Internal Revenue Service or Department of Education could enact, but failed to lay out a timeline or make a compelling case that the measures would be as effective as action by Treasury, according to the aide.

“After months of work, it was a big and disappointing loss,” the aide said.

These Democratic members of Congress for months had been asking Treasury to officially declare that Americans with student debt who are eligible for the “Total and Permanent Disability” loan discharge ― a category of borrowers with especially severe disabilities ― would not risk an income-tax penalty. Otherwise, there is a chance that the discharged loan would count as income subject to taxation, costing already-impoverished borrowers a potentially significant sum, they noted.

A Treasury spokesman did not dispute the aide’s account.

“The Obama Administration has repeatedly urged Congress to enact legislative changes to address the possible tax consequences of loan forgiveness faced by these borrowers, as well as others with student loans,” Treasury spokesman Rob Runyan said in a statement. “Congress has not yet enacted these legislative changes. Treasury continues to work with the Department of Education to evaluate possible alternatives that could address the situations faced by these borrowers‎.”

Borrowers qualify for the “Total and Permanent Disability” loan discharge if they receive Social Security Disability Insurance or Supplemental Security Income benefits, and the Social Security Administration has given them the designation “medical improvement not expected,” meaning recovery is highly unlikely. They must also earn no more than the federal poverty level for a family of two ― about $16,000 a year in 2016.

The Department of Education announced in April that it would try to make it easier for these severely disabled borrowers to obtain debt forgiveness by notifying them of their eligibility. Working with the Social Security Administration, the department identified 387,000 severely disabled borrowers eligible for the forgiveness.

The Democrats began working behind the scenes to encourage Treasury to write the guidance protecting these struggling borrowers from a burdensome IRS tax. Frustrated by months of fruitless discussion, Sen. Elizabeth Warren (D-Mass.) sent a private letter to Treasury Secretary Jack Lew and IRS Commissioner John Koskinen.

“Treasury’s failure to provide guidance will impose an extraordinary compliance burden on Social Security beneficiaries with total and permanent disabilities, while also triggering unnecessary administrative burdens on both the IRS and the ED,” Warren wrote in the Oct. 7 letter.

After months of work, it was a big and disappointing loss. Democratic Senate aide

The Congressional Progressive Caucus sent Lew a letter this month asking for the guidance.

Warren noted in the letter that most borrowers eligible for “total and permanent disability” loan discharge undoubtedly meet Treasury’s definition of “insolvency,” which applies to borrowers with debts exceeding assets. Under current tax law, Treasury must exempt a loan discharge amount from being counted as income for tax purposes if the borrower meets this definition of insolvency.

The average student loan burden of workers who would be affected by the guidance is about $18,000, according to a calculation the Department of Education performed for Warren that she included in her letter. The median net worth of people receiving Supplemental Security Income and Social Security Disability insurance is $1,500, according to an analysis conducted by the Center for Retirement Research at Boston College at Warren’s behest.

In addition, Warren observed in the letter, the Social Security Administration estimated in 2014 that 84 percent of the narrower category of severely disabled workers with the designation “medical improvement not expected” had no annual earnings.

“During the meeting they conceded that roughly two-thirds of these borrowers, who are already known to be in poverty, are also insolvent, but rejected the idea of providing guidance to even this subset of borrowers,” the Democratic Senate aide said.

Treasury’s failure to act means these impoverished, disabled borrowers will have to navigate IRS rules on their own. The IRS is likely to determine that the discharged loan was not a form of income, since the vast majority of the borrowers are insolvent.

But the borrowers may face an automatic audit, pushing them to engage expensive tax advisory services and experience great personal stress.

“Ultimately, given the costs of filing and the potential risks of garnishment, additional tax credits, or other federal and state benefits, the streamlined loan discharge process could leave borrowers who are totally and permanently disabled even worse off than before their loan was discharged,” Warren wrote in the letter.

Treasury has already issued guidance this year exempting certain kinds of loan discharges from counting toward taxable income for two far less vulnerable categories of borrowers: real estate investors and grantor trusts.

The Treasury spokesman didn’t respond to HuffPost’s request for an explanation why it was possible to exclude those types of discharged debts from taxable income, but not the outstanding student debt of impoverished people with disabilities.

Treasury’s rejection of Warren’s proposal comes amid mounting evidence that student debt is worsening elderly poverty.

In 2015 alone, the federal government garnished 110,000 seniors’ Social Security benefits to pay off student loans on which they had already defaulted, according to a Government Accountability Office study requested by Warren and Sen. Claire McCaskill (D-Mo.) that came out this week. Some 70,000 Americans over 50 live in poverty as their Social Security benefits are cut to pay off student debts, the report found.