Is Student Loan Discharge Income

Answer 1

The taxpayer in Plotinsky, TC Memo 2008-244 was taxed on the portion of his student loan that was canceled by the lender. The court rejected his contention that the debt discharge was a tax-free gift. The taxpayer financed a portion of his college and law school education with several federal loans. After graduating from law school, he consolidated his loans by borrowing from Key Bank USA/American Education Services (AES). To induces individuals to enter into loan consolidation agreements, AES offered an on-time payment incentive program. Under the program, AES would discharge a portion of a loan on which an individual made 36 consecutive on-time monthly payments. The promissory note and the repayment schedule that the taxpayer signed and that evidenced the taxpayer's consolidated student loan did not refer to the incentive program. Nonetheless, when the taxpayer made 36 consecutive on-time payments, AES discharged $3,043 of the consolidated loan. AES issued to the taxpayer Form 1099-C, Cancellation of Debt, showing the debt amount that was discharged. The taxpayer, however, did not include this amount on his income tax return. Rather, he attached a statement to his return indicating that he was not reporting the debt discharge as income because it was a gift. Section 102(a) excludes from gross income the value of property acquired by gift. The taxpayer reasoned that AES received nothing from him in return for the debt discharge. He was already contractually obligated to make on-time payments. As a release of something for nothing, the taxpayer argued that the discharged debt can be construed only as a gift. The court, however, disagreed with this reasoning. AES offered the incentive program to induce students, such as the taxpayer, to consolidate their student loans with it. Thus, it did receive something from the taxpayer in return. Even if AES had not received anything in return for the debt discharge, the Tax Court determined that the discharged debt was taxable. The court cited Duberstein, 5 AFTR 2d 1626 , 363 US 278 , 4 L Ed 2d 1218 , 60-2 USTC ¶9515 , 1960-2 CB 428 (1960), for the proposition that the term "gift" is used in a more colloquial sense than its common law usage. A voluntary transfer of property without any consideration or compensation is a common-law gift, but it is not necessarily a gift for tax purposes. For instance, a payment that is made due to the incentive of an economic benefit is not a gift for this purpose. Thus, the transferor's intent is the most critical consideration for determining whether a gift occurred. In this case, the court determined that AES did not discharge $3,043 of the taxpayer's consolidated student loan out of detached and disinterested generosity. Rather, it offered the incentive program to get individuals like the taxpayer to consolidate their student loans with AES. As such, the discharged debt amount is includable in the taxpayer's gross income.