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President Joe   Biden Outlines New Plans to Deliver Student Debt Relief to Over 30 Million Americans Under the Biden- ⁠ Harris Administration

Today, Biden-Harris Administration leaders will fan out across the country as President Biden announces his Administration’s new plans to cancel student debt for tens of millions of Americans . The plans, if implemented, would provide debt relief to over 30 million Americans when combined with actions the Biden-Harris Administration has already taken to cancel student debt over the past three years. While Republican elected officials try every which way to block millions of their own constituents from receiving student debt cancellation, President Biden has vowed to use every tool available to cancel student debt for as many borrowers as possible, as quickly as possible. Today, President Biden will travel to Madison, Wisconsin to announce these new plans, while Vice President Harris will travel to Philadelphia, Pennsylvania, Second Gentleman Douglas Emhoff will travel to Phoenix, Arizona, and Secretary of Education Miguel Cardona will travel to New York City to meet with borrowers benefitting from the Administration’s student debt relief actions.

President Biden from Day One has worked to fix the student loan system and make sure higher education is a ticket to the middle class – not a barrier to opportunity – because he knows that debt cancellation not only benefits borrowers, it benefits the entire economy.  

To date, the Biden-Harris Administration has approved $146 billion in student debt relief for 4 million Americans through more than two dozen executive actions. That includes fixing Public Service Loan Forgiveness and Income-Driven Repayment plans, so borrowers finally get the relief they are entitled to under the law. It also includes launching the most affordable student loan repayment plan ever – the SAVE plan – which cuts undergraduate loan payments in half, ensures borrowers never see their balance grow from unpaid interest, helps drop millions of borrowers’ monthly payments down to $0, and cancels debt for low-balance borrowers faster. Nearly 8 million borrowers have enrolled in the SAVE plan, 4.5 million borrowers have a monthly payment of $0 under the plan, and an additional 1 million borrowers have a monthly payment of less than $100.  The Biden-Administration has also secured the largest increase to Pell Grants in a decade and has taken significant steps to hold colleges accountable for leaving borrowers with mountains of debt and without good job prospects.

Last June, in the wake of the Supreme Court’s decision blocking the Biden-Harris Administration’s original student debt relief plan, President Biden vowed to keep fighting to deliver student debt relief to borrowers held back by the burden of student loan debt. Immediately following that, the Department of Education began pursuing an alternative path to debt relief through negotiated rulemaking under the Higher Education Act.

Today’s announcement lays out the plans the Biden-Harris Administration is pursuing through that effort. In total, these plans would fully eliminate accrued interest for 23 million borrowers, would cancel the full amount of student debt for over 4 million borrowers, and provide more than 10 million borrowers with at least $5,000 in debt relief or more.

Canceling runaway interest for millions of borrowers

More than 25 million borrowers owe more than they originally borrowed, including many who have made years of payments, due to the interest rates on Federal student loans. President Biden will announce plans that, if finalized as proposed, would cancel up to $20,000 of the amount a borrower’s balance has grown due to unpaid interest on their loans after entering repayment, regardless of their income. Low and middle-income borrowers enrolled in the SAVE plan or any other income-driven repayment (IDR) plan would be eligible for the entire amount their balance has grown since entering repayment to be canceled under the Administration’s plans. This group of borrowers includes single borrowers who earn $120,000 or less and married borrowers who earn $240,000 or less. No application will be needed for borrowers to receive this relief if the plan is implemented as proposed.

Millions of the borrowers who could be helped by these plans have continued to see their balances grow because of accrued interest, despite making their monthly payments.  Many have also had this unpaid interest capitalized, meaning it is added to their principal balance and borrowers are now paying interest on that higher amount. The Administration’s plan would forgive interest balances built up to date for 25 million borrowers, with 23 million likely to have all of their balance growth forgiven.   

This plan builds off the actions the Biden-Harris Administration has already taken to prevent the negative effects of excessive interest accrual on student loans going forward by eliminating all interest capitalization not required by law. The SAVE Plan does not charge unpaid interest for borrowers who make their monthly payments, and has canceled interest for at least 4.5 million borrowers to date.

Automatically canceling debt for borrowers eligible for loan forgiveness under SAVE, PSLF, closed school discharge, or other forgiveness programs but not enrolled

Too many borrowers eligible for relief – including immediate cancellation –have not been able to overcome paperwork requirements, bad advice, or other obstacles. Since its first days in office, the Biden-Harris Administration has worked to get borrowers the relief to which they are entitled.

Today, the Administration is proposing to automatically cancel debt for borrowers otherwise eligible for relief through the SAVE plan, Public Service Loan Forgiveness, or other forgiveness opportunities like closed school loan discharges but who have not successfully applied for that assistance.

Under SAVE, borrowers who originally took out $12,000 or less in loans and have been in repayment for 10 years are eligible to get their remaining debt canceled. For every additional $1,000 in loans they took out (up to $21,000 total for undergraduate loans and $26,000 total for graduate loans), a borrower is eligible for relief after an additional year of repayment. For example, if a borrower took out $13,000 in loans, they would be eligible for debt cancellation after 11 years in repayment.

Under Public Service Loan Forgiveness, borrowers in public service for 10 years who have made 120 months of qualifying payments can get their remaining student debt canceled.

The Administration’s plans would allow the Department of Education to use data it has on hand to identify borrowers otherwise eligible for this type of relief without requiring them to apply for these programs. The Administration expects this action would cancel debt for around 2 million borrowers across the country.  

Canceling student debt for borrowers who entered repayment over 20 years ago

More than 2.5 million borrowers have had their share of student loans for two decades or longer and still carry debt from long-ago loans. The Biden-Harris Administration has already cancelled $45.6 billion in student debt so far for nearly 1 million borrowers who have been in repayment for at least 20 years, but never got the relief they were entitled to because of administrative problems with income-driven repayment plans. The Administration’s new proposals, if finalized as proposed, would cancel student debt for borrowers who first entered repayment 20 or more years ago. Borrowers with only undergraduate debt would qualify for forgiveness if they first entered repayment 20 years ago (on or before July 1, 2005), and borrowers with any graduate school debt would qualify if they first entered repayment 25 or more years ago (on or before July 1, 2000). Both Direct Loans and Direct Consolidation Loans that repay only undergraduate study or graduate study for 20 or 25 years respectively are eligible for relief in this proposal.  Borrowers would not need to be on an income-driven repayment plan to qualify.

Canceling student debt for borrowers who enrolled in low-financial-value programs

One of the Biden-Harris Administration’s top priorities when it comes to higher education is holding colleges accountable when they leave students with mountains of debt and without good job prospects. To this end, the Department has taken significant steps to crack down on colleges that provide low-value programs to borrowers, when they cheat students and families, and when they close unexpectedly – leaving borrowers and taxpayers to foot the bill.

Today, President Biden is announcing his Administration’s plans that, if finalized as proposed, would cancel student debt for loans associated with institutions or programs that lost their eligibility to participate in the Federal student aid program or were denied recertification because they cheated or took advantage of students. Further, borrowers who attended institutions or programs that closed and failed to provide sufficient value— for example that leave graduates with unaffordable loan payments or earnings no better than what someone with a high school diploma earns— would be eligible for relief under this proposal.

Canceling student debt for borrowers experiencing hardship paying back their loans

President Biden and his Administration recognize that the current student loan system and repayment programs don’t reach all borrowers, and for many Americans student loans continue to be a barrier for them participating in the economy, accessing economic mobility, or pursuing their dreams. The Administration’s plan for student debt relief will also include a plan that would cancel student debt for borrowers experiencing hardship in their daily lives that prevents them from fully paying back their loans now or in the future.

This plan could provide relief to millions of borrowers who experience hardship—such as borrowers who are at high risk of defaulting on their student loans, who could be eligible for automatic relief, or families who are burdened with other expenses like medical debt or child care who can apply for relief in the future.

Providing relief to millions of borrowers this year

The Biden-Harris Administration plans to release proposed rules on these plans over the coming months. If these plans are finalized as proposed, this fall the Administration would begin canceling up to $20,000 in interest for millions of borrowers and full loan forgiveness for millions more.    

Building off unparalleled record canceling student debt under President Biden

Today’s announcements follow historic actions the President and his Administration have already taken to approve student debt cancellation for nearly 4 million Americans and make student loan payments easier for millions more through the SAVE plan. These actions have benefited borrowers from all 50 states and U.S. territories, borrowers from different walks of life, and borrowers of all ages. To date:

• The Administration has canceled over $62.5 billion in student debt for 871,000 public service workers, including teachers, firefighters, nurses, and more. Prior to the Biden Administration, only 7,000 people in total had received debt forgiveness through Public Service Loan Forgiveness in the over 15 years since the program was put in place. The Biden Administration implemented fixes to make sure public service workers received the relief they are entitled to under the law, helping nearly 900,000 public service workers receive relief to date.
• The Administration has approved $45.6 billion in debt cancellation for nearly 1 million borrowers through fixes to income-driven repayment. For too long, as a result of administrative failures and loan servicer errors, borrowers never got credit for being in repayment. The Biden-Harris Administration fixed that, and has approved debt cancellation for over 930,000 borrowers who have been in repayment for over 20 years.
• The Administration has approved $22.5 billion in debt cancellation for borrowers cheated by their schools, who saw their schools abruptly close, or who were covered by related court settlements. The Administration has approved borrower defense and closed school discharges to provide debt cancellation for students that attended and were cheated by for-profit institutions like Corinthian Colleges and ITT Technical Institute. Less than $600 million in debt relief had been approved through borrower defense, closed school discharges, and related court settlements from all prior administrations combined, compared to the $22.5 billion approved under the Biden-Harris Administration alone.
• The Administration has approved $14 billion in debt cancellation for over 548,000 borrowers with a total and permanent disability. Through automatic matches with the Social Security Administration and other actions, the Biden-Harris Administration has approved debt cancellation for over half a million borrowers with total and permanent disabilities.
• The Administration launched the SAVE plan – helping borrowers of all ages and walks of life manage their monthly payments, not charging interest for millions of borrowers, and setting $0 payments for 4.5 million borrowers every month. To date, nearly 8 million borrowers have enrolled in SAVE, and 4.5 million of them have a monthly payment of $0, meaning they are also not accumulating interest that would otherwise be due. An additional million borrowers have a monthly payment of less than $100. Already the Administration has canceled debt for 153,000 borrowers enrolled in SAVE who took out low balances and have been in repayment for at least 10 years. And in July, the SAVE plan will cap monthly payments for undergraduate loans at 5% of income compared to the 10% threshold now – which will save many young borrowers money on their monthly payments. The Administration continues to encourage borrowers to sign up for the SAVE plan at studentaid.gov/SAVE to save money on their monthly payments and reach loan forgiveness faster.
• The Administration secured the largest increase to Pell Grants in a decade, and has expanded eligibility for the maximum Pell Grant to 1.7 million more Americans. The President has taken historic steps to bring college in reach for more Americans, including low-income Americans. The President secured the largest increase to Pell Grants in a decade, expanded eligibility to Pell to 665,000 new students, and expanded eligibility for the maximum Pell Grant to 1.7 million more students. The President has also proposed making community college free so more Americans can access the promise of higher education.

President Biden will not stop fighting to cancel more student debt for as many Americans as possible, and today’s announcements are a key step forward in that effort.

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5 student loan forgiveness application updates borrowers should know about.

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US Education Secretary Miguel Cardona (R) looks on as US President Joe Biden delivers remarks on ... [+] student loan forgiveness in the South Court Auditorium of the Eisenhower Executive Office Building, next to the White House, in Washington, DC, on October 17, 2022. (Photo by Brendan SMIALOWSKI / AFP) (Photo by BRENDAN SMIALOWSKI/AFP via Getty Images)

The Biden administration has approved an unprecedented amount of student loan forgiveness for more than four million borrowers, and more relief may be on the way. But there have been many changes and updates to student debt programs and application processes, with some big updates in just the last few weeks. Navigating the already-complex student loan system amid this tumult can present challenges.

President Biden has taken a two-track approach to enacting broad student debt relief. He has implemented a number of program changes and temporary waivers to several existing loan forgiveness programs. Collectively, these “targeted” initiatives have led to $153 billion in student loan forgiveness. At the same time, the administration has been moving forward with a new student debt relief program that, if implemented, could dramatically expand these approvals . The Education Department released draft regulations for this new program last week. The plan must clear a few more steps before relief would be available, but that could happen this fall.

Here’s what borrowers need to know about applying for current and forthcoming student loan forgiveness initiatives.

Applying For Student Loan Forgiveness Under the Account Adjustment

The Biden administration has approved upwards of $49 billion in loan forgiveness for just under a million borrowers under the IDR Account Adjustment. This temporary initiative can accelerate progress toward loan forgiveness under income-driven plans, a type of federal student loan repayment plan that allows borrowers to make payments based on a formula applied to their income.

IDR enrollees can typically qualify for a discharge after 20 or 25 years in repayment, depending on their specific circumstances. The account adjustment allows past loan periods that may not have counted toward IDR loan forgiveness — such as payments made under other plans, and certain periods of deferment and forbearance — to count.

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There is no formal application for student loan forgiveness under the IDR Account Adjustment. The Education Department is implementing the relief automatically for borrowers who have government-held federal student loans . The department has been approving discharges on a rolling basis every two months, and expects to complete implementation this July.

But some borrowers will need to submit some type of application in order to qualify for relief under the adjustment:

• Borrowers who have federal student loans not directly owned or held by the Education Department — such as commercial FFEL loans, school-issued Perkins loans, and HEAL loans for medical professionals — must submit a Direct consolidation application by April 30th in order to receive the benefits of the IDR Account Adjustment. This represents the most recent deadline extension by the department. As of this writing, the department has not extended the deadline again, suggesting April 30th is the final submission cutoff.
• Those who expect to receive IDR credit under the adjustment but will be short of the threshold for immediate loan forgiveness would need to apply to switch to an IDR plan (if they are not already in one) so they can continue progressing toward an eventual discharge.

The Direct consolidation and IDR applications can be accessed online at StudentAid.gov .

Applying For Student Loan Forgiveness Through PSLF

The Public Service Loan Forgiveness program can shorten a borrower’s student loan forgiveness timeline to as little as 10 years if they work in qualifying nonprofit or public employment. The Biden administration has made meaningful changes to the PSLF program through a combination of temporary waivers and more-lasting regulatory reforms, resulting in 876,000 borrowers getting approved for over $60 billion in loan forgiveness, according to the Education Department.

Only Direct loans qualify for PSLF, meaning borrowers who have non-Direct federal student loans would need to apply to consolidate through the Direct loan program. And borrowers seeking PSLF credit under the IDR Account Adjustment would need to do this prior to April 30th.

In addition, to get PSLF credit borrowers must certify their employment using the online PSLF application system. However, the entire PSLF application and processing system is temporarily shutting down starting on May 1st. During that time, borrowers can submit PSLF forms, but they will not be processed and no one will get student loan forgiveness under the program until processing resumes in July. At that time, borrowers will be able to access their PSLF information through a new StudentAid.gov dashboard.

Applying For Student Loan Forgiveness Based On A Borrower’s Medical Condition

Close to 550,000 borrowers have received $14.1 billion in student loan forgiveness due to changes and improvements to the Total and Permanent Disability discharge program, according to the Education Department. The TPD discharge program can wipe out the federal student loan debt for those who are unable to maintain significant employment due to a disabling medical condition, whether physical or psychological.

The Biden administration recently updated the TPD discharge application to reflect new regulations that went into effect last summer. The reforms expand the types of medical providers who can certify that a borrower meets the TPD standard, and broaden the categories of people who can qualify for automatic relief based on receiving Social Security disability benefits.

The TPD discharge program will likely go through an application processing pause similar to PSLF later this year, although the administration has not yet provided a specific timeline.

Applying For Student Loan Forgiveness Through Borrower Defense To Repayment

The Education Department has approved upwards of $22 billion in student loan forgiveness for more than a million borrowers who were subject to certain types of school misconduct. A portion of that relief was approved through the Borrower Defense to Repayment program, with allows borrowers to request a discharge if their school misled them about core elements of their degree or certificate program.

The Borrower Defense program typically requires a long application detailing how the school engaged in misrepresentations. The Biden administration updated regulations governing the program last summer, providing additional avenues for relief and removing some previous restrictions (such as a statute of limitations) that could have blocked some borrowers from receiving any loan forgiveness under the program.

But a legal challenge has resulted in those new regulations being blocked. In a ruling earlier this month, a federal appeals court suggested that these new, more borrower-favorable rules are likely to ultimately get struck down . That puts the Education Department in a bind — officials cannot currently use the new regulations when evaluating Borrower Defense applications because of the court injunction, but they don’t necessarily want to deny people under the older set of rules while the legal process plays out (unless they have to under other court orders).

Consequently, many applications for student loan forgiveness under Borrower Defense are effectively stuck in a limbo status. Borrowers can apply, but they may not get a decision for quite some time.

“The Department will not adjudicate any borrower defense applications under the latest rule unless and until the effective date is reinstated,” says the department. “While this injunction is in effect, borrowers may still apply online for borrower defense relief. The Department will continue to adjudicate borrower defense applications using an earlier version of the regulations where required under a court settlement.”

Applying For Forthcoming Biden Student Loan Forgiveness Plan

Earlier this month, President Biden announced that a new student loan forgiveness plan is coming. The new initiative, billed as a replacement for the one that the Supreme Court struck down last year, is designed to provide relief to several groups of borrowers based on their circumstances.

According to draft regulations, many borrowers could receive loan forgiveness automatically under the new program, without needing to submit an application. This includes those who have experienced significant compounded interest , borrowers who first entered repayment 20 or 25 years ago, and people who would be eligible for loan forgiveness under other programs but haven’t applied or enrolled.

Other borrowers, such as those experiencing financial hardship, will likely need to submit an application for loan forgiveness. However, that application is not yet available. The new program must first undergo several more steps, including completing a public comment period followed by the adoption of the final version of the rules. Officials have indicated that the program, and any associated loan forgiveness application, could launch by this fall, although it will almost certainly face legal challenges.

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Student loan forgiveness: What you need to know before April 30

To be eligible for cancellation of your debt, you might have to first consolidate your loans., by noreen o'donnell • published 2 hours ago.

A key deadline is approaching fast for an opportunity for a student loan cancellation. 

If you are a federal student loan borrower you could have the chance to receive a full cancellation of your debt or credit towards cancellation through a one-time U.S. Department of Education payment-count adjustment. But to be eligible you might have to first consolidate your loans.  

And you must take that step by Tuesday, April 30.

The Biden administration is cancelling federal student debt for millions of undergraduate or graduate students and providing some relief to millions of others. In all more than 30 million Americans will benefit, according to NBC News.

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More than four million borrowers will have the full amount of their student debt cancelled, 10 million will be eligible for at least $5,000 in debt relief and 23 million borrowers will see their accrued interest eliminated.

The U.S. Department of Education will make the one-time adjustment over summer.

Here’s what you need to know.

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What loans must be consolidated.

If you have any of the federally managed loans that are listed here, you must consolidate them to get the most credit toward loan cancellation.

• Commercially held Federal Education Loans or FFELs.
• Parent PLUS loans
• Perkins loans
• Health Education Assistance Loan Program or HEAL loans

If you are not sure about what kind of loan you have, log in to your account at StudentAid.gov or call the U.S. Department of Education’s Federal Student Aid Information Center at 1-800-433-3243.

Your new Direct Consolidation Loan will be eligible for the one-time adjustment this summer.

When is the deadline to consolidate? 

Tuesday, April 30.

In the News

Student loan borrowers could have up to $20,000 in interest forgiven as early as this fall—here's who qualifies

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Women with student loan debt face ‘multiple financial pressures,' expert says. These tips may help with repayment

How do i apply to consolidate my loans.

Sign on to StudentAid.gov/loan-consolidation to choose the loans you want to consolidate and determine a monthly repayment plan for your new loan. You can also get help at the Federal Student Aid Information Center at 1-800-433-3243.

There is no application fee. 

Some special details about Parent PLUS loans

If you have made at least 25 years or 300 months of repayment toward your Parent PLUS loan managed by the U.S. Department of Education, your loan will be cancelled automatically as part of the one-time adjustment. Otherwise you should consolidate the loan.

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Is it fair to forgive student loans? Examining 3 of the arguments of a heated debate

Scott Horsley

Student loan borrowers stage a rally in front of The White House on Aug. 25 to celebrate President Biden cancelling student debt. The plan has sparked heated debate, including about its economic fairness. Paul Morigi/Getty Images for We the 45m hide caption

Student loan borrowers stage a rally in front of The White House on Aug. 25 to celebrate President Biden cancelling student debt. The plan has sparked heated debate, including about its economic fairness.

President Biden's plan to forgive hundreds of billions of dollars in student debt is sparking heated debate.

Biden last week announced plans to forgive up to $20,000 in federal student loan debt for Pell Grant recipients and up to $10,000 for others who qualify.

The news will provide relief for borrowers at a time when the cost of higher education has surged.

Student loan forgiveness is politically popular. But not all Democrats are on board

But critics are questioning the fairness of the plan and warn about the potential impact on inflation should the students with the forgiven loans increase their spending.

Here are three key arguments – for and against the wisdom of Biden's decision.

Raising living standards or adding fuel to inflation?

Undoubtedly, student debt is a big burden for a lot of people.

Under Biden's plan, 43 million people stand to have their loan payments reduced, while 20 million would have their debt forgiven altogether.

People whose payments are cut or eliminated should have more money to spend elsewhere – maybe to buy a car, put a down payment on a house or even put money aside for their own kids' college savings plan. So the debt forgiveness has the potential to raise the living standard for tens of millions of people.

Critics, however, say that additional spending power would just pour more gasoline on the inflationary fire in an economy where businesses are already struggling to keep up with consumer demand.

Inflation remains near its highest rate in 40 years and the Federal Reserve is moving to aggressively raise interest rates in hopes of bringing prices back under control.

Not all economists believe the debt forgiveness will do much to fuel inflation.

Debt forgiveness is not like the $1200 relief checks the government sent out last year, which some experts say added to inflationary pressure. Borrowers won't suddenly have $20,000 deposited in their bank accounts. Instead, they'll be relieved of making loan payments over many years.

President Biden announces student loan relief in the Roosevelt Room of the White House in Washington, D.C. on Aug. 24. Olivier Douliery/AFP via Getty Images hide caption

President Biden announces student loan relief in the Roosevelt Room of the White House in Washington, D.C. on Aug. 24.

Because the relief is dribbled out slowly, Ali Bustamante, who's with left-leaning Roosevelt Institute says Biden's move won't move the needle on inflation very much.

"It's just really a drop in the bucket when it come to just the massive level of consumer spending in our very service- and consumer-driven economy," he says.

The White House also notes that borrowers who still have outstanding student debt will have to start making payments again next year. Those payments have been on hold throughout the pandemic.

Restarting them will take money out of borrower's pockets, offsetting some of the additional spending power that comes from loan forgiveness.

Helping lower income Americans or a sop to the rich?

Another big point of contention has to do with fairness.

Forgiving loans would would effectively transfer hundreds of billions of dollars in debt from individuals and families to the federal government, and ultimately, the taxpayers.

Some believe that transfer effectively penalizes people who scrimped and saved to pay for college, as well as the majority of Americans who don't go to college.

They might not mind subsidizing a newly minted social worker, making $25,000 a year. But they might bristle at underwriting debt relief for a business school graduate who's about to go to Wall Street and earn six figures.

Students from George Washington University wear their graduation gowns outside of the White House in Washington, D.C, on May 18. Economists worry President Biden's plan to forgive student loans could encourage more people to take on debt in the hopes of also being forgiven. Stefani Reynolds/AFP via Getty Images hide caption

Students from George Washington University wear their graduation gowns outside of the White House in Washington, D.C, on May 18. Economists worry President Biden's plan to forgive student loans could encourage more people to take on debt in the hopes of also being forgiven.

The White House estimates 90% of the debt relief would go to people making under $75,000 a year. Lower-income borrowers who qualified for Pell Grants in college are eligible for twice as much debt forgiveness as other borrowers.

But individuals making as much as $125,000 and couples making up to $250,000 are eligible for some debt forgiveness. Subsidizing college for those upper-income borrowers might rub people the wrong way.

"I still think a lot of this benefit is going to go to doctors, lawyers, MBAs, other graduates that have very high earnings potential and may even have very high earnings this year already," says Marc Goldwein senior policy director at the Committee for a Responsible Federal Budget.

Helping those in need or making college tuition worse?

Goldwein also complains that the loan forgiveness doesn't address the larger problem of soaring college tuition costs.

In fact, he suggests, it might make that problem worse — like a Band-Aid that masks a more serious infection underneath.

For years, the cost of college education has risen much faster than inflation, which is one reason student debt has exploded.

And now what? The question that follows Biden's student loan forgiveness plan

By forgiving some of that debt, the government will provide relief to current and former students.

But Goldwein says the government might encourage future students to take on even more debt, while doing little to instill cost discipline at schools.

"People are going to assume there's a likelihood that debt is canceled again and again," Goldwein says. "And if you assume there's a likelihood it's canceled, you're going to be more likely to take out more debt up front. That's going to give colleges more pricing power to raise tuition without pressure and to offer more low-value degrees."

The old rule in economics is when the government subsidizes something, you tend to get more of it. And that includes high tuition and college debt.

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Biden's piecemeal student debt forgiveness 'transformational' for borrowers, advocates say

April 23 (UPI) -- In less than a year since the U.S. Supreme Court blocked President Joe Biden's student loan forgiveness, his administration has taken a piecemeal approach to forgiving billions of dollars in debt for millions of borrowers.

The president initially set out to cancel $10,000 to $20,000 of student debt for borrowers who received Pell Grants if they earned less than $125,000 per year. Tens of millions signed up for debt relief before the Supreme Court ruled against the plan in June.

Biden and the Department of Education have since announced more narrowly targeted debt cancellations for borrowers that meet certain requirements. Many who have had their debt canceled have been paying off their student loans for 10 years or more.

As of April 12, the White House said its efforts have resulted in $153 billion in debt relief for 4.3 million borrowers.

Fixing broken programs

Among the most impactful forms of relief, according to borrower advocates, were fixing the Public Service Loan Forgiveness and income-driven repayment programs.

The PSLF program was instituted in 2007 and was set to become active in 2017. It would allow borrowers who made 120 payments while working in public service to have their remaining balance forgiven.

Spencer Dixon, senior policy advisor for the Student Debt Crisis Center, told UPI, however, that the "program was so poorly managed" under President Donald Trump's administration that "only 7,000 people received relief under the program."

"Under Biden so far we've seen more than 100 times as many people benefit from the program," Dixon said.

In October 2022, the Department of Education announced permanent changes to the PSLF program including allowing borrowers working in the public service fields to obtain credit for late, partial or lump sum payments as well as offering credit for months in deferment or forbearance including those related to military service or deferments for economic hardship or cancer treatment.

Following a series of loan discharges the administration said it has since approved $62.8 billion in forgiveness for nearly 876,000 borrowers through the PSLF program.

As of April 12 , the Education Department said that more than 996,000 borrowers have also received relief under additional fixes to IDR programs with the administration approving $49.2 billion in debt relief.

The first relief announcement , following the Supreme Court's decision to block Biden's broader debt cancellation plan, was made on July 14. The Department of Education announced it would notify more than 804,000 borrowers that they qualified to have a total of $39 billion forgiven.

This batch of cancellations took place automatically. Borrowers that had made 240-300 monthly payments, the equivalent of 20-25 years on an IDR plan.

Additionally, in response to the Supreme Court's rejection of his broader student debt relief plan, Biden introduced the Saving on a Valuable Education Plan, or SAVE, which offers automatic relief to borrowers who have been making payments for more than 10 years if they initially took out loans of $12,000 or less.

In February, SAVE borrowers began receiving forgiveness ahead of the originally planned July deadline with $1.2 billion in loans forgiven, impacting nearly 153,000 people . The Education Department said more borrowers will eventually be forgiven as they hit the 10-year repayment threshold. There are about 7.5 million people signed up for the SAVE repayment plan.

In total, the Education Department said $3.6 billion loans for almost 206,800 borrowers have been forgiven under the program as of this month.

'This is transformational'

Repayment flexibility and debt relief have particularly benefited workers in the nonprofit world and government workers, according to Dixon. Lower- and middle-income families and Black and Latino families are also represented among those to be greatly impacted.

The Biden administration has emphasized debt relief for public service workers. Days after announcing the early SAVE plan forgiveness in January, the Biden administration canceled $5 billion for 74,000 public service workers . Teachers, nurses, firefighters and other public servants benefitted.

About 30,000 of those borrowers had been paying their student loans for 20 years. The rest had been paying for 10 years.

Debt relief has been crucial for educators, whether they are just starting their careers or nearing retirement. Becky Pringle, president of the National Education Association, told UPI that the impact for educators has been almost immediate.

"The early career educators who are taking two or three jobs and living with their colleagues in an apartment, all of that is real," Pringle said. "When that changes for them, they tell us about how it not only encouraged them to stay in the profession but that they can live their lives and start their families."

Pringle added that borrowers are often mischaracterized by opponents of debt relief as not paying their loans. However, those who have received relief have been paying toward their debt for 10 years or more in most cases. Some who have paid for a decade or longer had balances larger than their initial loan.

"They've been [paying] it but can't get out from under it because of the way it was structured," she said. "We found out that over 25% of educators over 61 had still not paid off their student loans. About 35% were carrying more than 45,000 of their debt."

Those debt terms have caused some of those educators to delay retirement or believe that retirement will never be an option.

"That's unbelievable and unacceptable," Pringle said.

Pringle and Amy Czulada, outreach and advocacy manager for the Student Borrower Protection Center, told UPI that student debt has caused many people to delay starting a family or purchasing a home.

"We were surprised to find out how many of our members were delaying starting families or buying houses because they were laboring under this debt," Pringle said."

With relief, Czulada says those people can begin to participate in the economy in a way they were not able to before.

"It's been a really exciting time to be doing this work," Czulada said. "It's the first time we've seen the ledger move down on student debt. In the past decade it's been ballooning. The stories we get from folks about what debt cancellation means to them are really inspiring. They're freer to do things they've wanted to do for a long time. This is transformational."

While the Biden administration has rolled out multiple efforts to broaden debt relief it is also seeking to implement a broader plan like originally intended. Last week it submitted a notice of proposal to waive certain student debt under the authority of the Higher Education Act.

"The plans, if implemented, would provide debt relief to over 30 million Americans when combined with actions the Biden-Harris Administration has already taken to cancel student debt over the past three years," the White House said in a statement.

"This plan b broad-based forgiveness is more targeted," Dixon said. "A reasonable person could say that it's in response to the way in which the first plan was struck down."

Czulada explains that this new proposal would seek to fill some gaps for those who have been missed by previous relief plans. It would also fix more programs that have not been working as intended.

The proposal would introduce a number of new regulations that would lower the debt burden for borrowers who have been making payments, experienced hardship or may have qualified for relief without knowing about it.

A portion of debt, or in some cases the full amount, could be waived if it exceeds the amount of the loan when it entered repayment if the borrower falls at or below certain income levels. Borrowers who were eligible for plans like the IDR plan could have their outstanding balance forgiven even if they are not enrolled.

However, Biden's piecemeal debt forgiveness plans have also come under fire.

Kansas Attorney General Kris Kobach has been among the most ardent opponents of canceling student debt. He organized a coalition of 11 states last month to sue the Biden administration over his efforts to forgive student debt. Alabama, Alaska, Idaho, Iowa, Louisiana, Montana, Nebraska, South Carolina, Texas and Utah joined the lawsuit.

Kobach alleges that Biden's plans have defied the Supreme Court's ruling and circumvented Congress.

Borrowers, don’t miss this important student loan forgiveness deadline

The deadline to consolidate student loans by april 30 is looming..

This is the season of college-related deadlines.

By May, colleges typically ask students to confirm which schools they will attend in the fall.

To be considered for federal student aid for the 2024-2025 academic year, applicants have to complete their Free Application for Federal Student Aid ( FAFSA ) form by June 30.

However, another important deadline is approaching for families already dealing with education debt. If you have student loans, meeting this April 30 deadline could result in thousands of dollars in loan forgiveness. Here’s what you need to know.

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Debt Forgiveness: The Options & Consequences

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Debt forgiveness is when one of your lenders forgives or erases some or all of your debt. This debt could be from a credit card, a student loan, or an installment loan. Sometimes you can get a full debt forgiven, but more often, you’ll get partial forgiveness. For example, if you come to a debt settlement agreement with a credit card company, you agree to pay part of your outstanding debt in exchange for having the rest of the debt erased. With many student loan forgiveness programs, you must pay a portion of your debt for a certain period of time before you get the remaining balance forgiven.

Written by Attorney Tina Tran .  Updated June 28, 2023

What Is Debt Forgiveness & How Does It Work?

Debt forgiveness is when one of your lenders forgives or erases some or all of your debt . This debt could be from a credit card, a student loan, or an installment loan. Sometimes you can get a full debt forgiven, but more often, you’ll get partial forgiveness. For example, if you come to a debt settlement agreement with a credit card company, you agree to pay part of your outstanding debt in exchange for having the rest of the debt erased.

Debt forgiveness isn’t always easy to come by. Usually, lenders that offer loan forgiveness programs have eligibility requirements. To determine whether and how much of your debt to forgive, your lender will consider your financial circumstances and how much debt you owe. 

Debt forgiveness is usually available for unsecured debts like credit cards, personal loans, or student loans. Secured debts like a mortgage or a car loan are not usually eligible for debt forgiveness. If you default on a secured debt, the lender will likely pursue foreclosure or repossession . If you are having difficulty paying the minimum payments on your secured debts, you should look at options like loan modification , a forbearance agreement, refinancing, or bankruptcy .

How Do You Get Debt Forgiveness?

Some people can get debt forgiveness by directly contacting and negotiating with their lenders. Other people prefer to hire a credit counselor , debt settlement company, or debt relief agency to help them manage their monthly payments, negotiate debt settlement agreements or lower interest rates, or get a debt consolidation loan.

When it comes to federal student loan debt relief, StudentAid.gov has the latest information on student loan forgiveness programs. The status of the student loan forgiveness plan and repayment options for federal student loans changes frequently. So pay attention to the news or subscribe to the U.S. Department of Education’s email list to stay caught up on the latest developments that could affect your student loans.

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What Are the Pros and Cons of Debt Forgiveness?

Debt forgiveness can help relieve financial stress and may be the ticket to shoring up your finances. But it can be difficult to get and has some consequences you’ll want to consider. 

Also, when it comes to debt relief of any kind, be aware of scams . Scam phone calls for student loan debt forgiveness have been on the rise in recent years, and several unreputable companies try to make money off people seeking debt forgiveness for credit card and other debt.

The Benefits of Debt Forgiveness

You can probably guess the biggest benefit of debt forgiveness: You no longer have to repay what was probably a quite burdensome debt. Even if you agree to a debt settlement and only have part of your debt forgiven, you benefit by paying less than the total amount you owed. 

Getting into debt can become a vicious cycle. If you’re struggling to repay one debt, odds are good that there are other debts you’re trying to manage as well. Having one debt forgiven can free up the resources to pay down other debts, avoid debt collection , or get on the path to becoming debt-free . If you have a debt management plan , debt forgiveness can expedite your plan and help you pay off your debt even sooner than expected.

The Downsides of Debt Forgiveness

As with most things in life, debt forgiveness has some downsides. You may see a dip in your credit score or have a bigger tax bill.

Your Credit Score May Drop as a Result of Debt Forgiveness or Settlement

Depending on the type of debt and type of forgiveness, you may see your credit score drop as a result. The lender or creditor agreeing to the debt settlement or forgiveness will likely report this activity to the major credit bureaus. Your account may be annotated as “settled” or “settled for less than the full balance.” Both of these are considered negative entries because they signal that you did not repay your debt on time and in full as agreed. 

That said, the damage may already be done here. Most lenders won’t agree to forgiveness or settlement until you’ve defaulted on your debt. That means by the time you come to the negotiating table, your credit score has likely already taken a serious hit. Learn more by reading our article How Debt Settlement Affects Your Credit Score .

Debt Forgiveness May Raise Your Taxable Income

Debt forgiveness may also have some tax consequences . The amount that’s forgiven will be counted as income on your upcoming tax return, which means you may have to pay income tax on it.  

Some Student Loan Forgiveness Programs Don’t Have These Negative Consequences

There’s one important caveat here. Student loan debt forgiveness programs like the popular Public Service Loan Forgiveness (PSLF) program, Teacher Loan Forgiveness , and Total and Permanent Disability Discharge do not come with these negative consequences. Participating in any of these forgiveness or cancellation programs will not negatively impact your credit score, and you won’t be responsible for paying taxes on student loan debt forgiven through the program.

However, if you participate in a 20–25-year i ncome-driven repayment program , any amount forgiven at the end of the payment period will be considered taxable income and may come with a sizable tax bill.

What Are the Different Types of Debt Forgiveness?

There are as many debt forgiveness options as there are types of debt! You may be able to find debt forgiveness programs or options for credit card debt, student loan debt, medical debt, tax debt, and more.

You may qualify for special debt forgiveness programs if you:

Are a low-income individual

Are on permanent disability

Have been affected by the coronavirus pandemic

Are a full-time student

Work in a qualifying occupation

Here’s more information about common types of debt forgiveness.

Student Loan Debt Forgiveness Options

Student loan forgiveness is a hot topic these days. Most people are familiar with the pandemic-related student loan repayment pause and the Biden administration’s proposed forgiveness plan. With the payment pause sunsetting by October 2023 and Biden’s forgiveness plan still under review by the Supreme Court, you may be wondering if student loan borrowers are left with any forgiveness options.

The good news is that several student debt relief options ]have continued outside the political chaos of Biden’s student loan forgiveness proposal.

The most popular and widely used program is the Public Service Loan Forgiveness (PSLF) program. To be eligible, you must work for a qualifying nonprofit or government organization. 

Student loan borrowers who participate in income-driven repayment plans are also eligible to have their remaining loan balances forgiven after the 20–25-year repayment period. Income-based repayment is also a great way to get a more manageable student loan payment since it’s based on your discretionary income and household size (instead of the length of the loan).

How Does Student Loan Forgiveness Work?

Student loan forgiveness works like ordinary debt forgiveness (sometimes called debt cancellation when referring to student loans), but it’s specific to federal student loans issued by the U.S. Department of Education. It doesn’t apply to student loans issued by private lenders like banks. 

Credit Card Debt Forgiveness Options

Credit card issuers and lenders are not as willing to negotiate debt forgiveness as you might hope because they have several debt collection tools. That said, credit card debt forgiveness is not impossible — especially if your debt has already been deemed uncollectible and you decide to pursue the path of debt settlement

For example, you might offer to pay 50% of the outstanding debt you owe in one lump sum. If your lender accepts this offer, the remaining 50% of your debt will be forgiven. Again, beware that this may lower your credit score and have tax consequences.

If you want to learn more, check out our article on 5 Solid Steps for Negotiating With Debt Collectors .

Don’t Qualify for Debt Forgiveness? Consider Filing for Bankruptcy

If you feel like you’ve tried everything and just can’t get ahead, you may want to look into filing for bankruptcy . 

In Chapter 7 bankruptcy , most of your debts are erased , and you get a fresh start. You can even have federal Direct Loans discharged in bankruptcy if you meet eligibility requirements . Upsolve offers many resources for bankruptcy including a free online filing tool and access to a free consultation with a private attorney .

Let’s Summarize...

Debt forgiveness can be a great tool in the right circumstances. For credit card debt, lenders may require you to pay part of the debt, then forgive the rest. Debt forgiveness can relieve financial stress, but keep in mind your credit score may suffer and your tax bill may increase. 

Thankfully, student loan forgiveness programs (except for forgiveness following the completion of an income-based repayment plan) don’t come with these same negative consequences. To help with the federal student loan debt crisis, the U.S. Department of Education offers several loan forgiveness programs that only apply to federal education loans.

Attorney Tina Tran

Tina Tran is the managing bankruptcy attorney for Upsolve, the largest consumer bankruptcy non-profit in the United States. She received her Juris Doctorate degree and Certificate in Advocacy from Loyola University Chicago School of Law. She is licensed to practice law in Illinoi... read more about Attorney Tina Tran

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Credit card debt forgiveness: 3 things to know before signing up

By Joshua Rodriguez

Edited By Angelica Leicht

March 8, 2024 / 11:07 AM EST / CBS News

Credit card debt can be an overwhelming challenge for a lot of people — especially right now. Persistent inflation has caused the Federal Reserve to hike interest rates several times over the last couple of years, and, in turn, credit card rates — which are variable — have also increased. Those higher rates have caused rising credit card balances —  now totaling 1.13 trillion nationwide — making it difficult for those with high balances to pay off what they owe.

If you're currently overwhelmed by your credit card debt, you may be considering  credit card debt forgiveness programs . While these programs can offer an effective way to get out of credit card debt , it's important to educate yourself on the topic before signing up.  

Find out how much relief credit card debt forgiveness may be able to provide today . 

Here are a few things you should know before you enroll in a credit card debt forgiveness program:

Credit card debt forgiveness typically takes 24 to 48 months

Debt forgiveness typically happens as part of a debt relief service known as credit card debt settlement. With this process, you typically stop making credit card payments and start sending payments to your debt relief provider instead. 

These payments are held in a special-purpose savings account, and once you have enough money saved to settle your debts, the debt relief company starts negotiating settlements with your creditors. If your creditors approve the settlements, they'll accept a lesser amount than what you owe to pay off your credit card debt — forgiving the remainder of your balance. 

Depending on the provider, this process generally takes anywhere from 24 to 48 months . However, it can take more or less time depending on the debt forgiveness provider you choose and your unique circumstances. 

Learn more and enroll in credit card debt forgiveness now . 

Credit card companies don't usually forgive 100% of your debt

In most cases, the only way that credit card companies will forgive 100% of your debt is if you file for bankruptcy . With credit card debt forgiveness, the debt relief provider negotiates settlements  after months of nonpayment. 

In turn, they may be willing to forgive a portion of your balance to receive at least some payment on what you owe. However, they'll probably want a reasonable settlement amount in return. 

There are some potential drawbacks to credit card debt forgiveness

There are a few potential disadvantages to consider before you seek debt forgiveness, including: 

• The credit score impact : Stopping your credit card payments is an important part of the credit card debt forgiveness process, but it can damage your credit score. And, once you've settled, your creditors will likely report the debt to credit reporting agencies as "settled" rather than "paid as agreed," potentially causing further harm to your credit score . 
• The potential tax implications : If a portion of your credit card debt is forgiven, it's considered income by the IRS. So, you may have to pay income taxes on the forgiven amount. 
• There are no guarantees : Credit card companies aren't required to accept settlement offers — so not all negotiations will be successful. However, if your creditors don't agree to settle, the debt relief company will return the money you saved through the program for your settlements. 

The bottom line

Credit card debt forgiveness can be a smart way to pay off debt you can't afford, but keep in mind that creditors don't typically forgive 100% of your debt and it can take a while to complete a debt forgiveness program. There are also credit and tax implications to consider. However, if you're facing debt that you can't pay off, credit card debt forgiveness could be an effective way to ease the financial hardship. 

Joshua Rodriguez is a personal finance and investing writer with a passion for his craft. When he's not working, he enjoys time with his wife, two kids, two dogs and two ducks.

More from CBS News

Here's how much credit card debt the average American has (and how to pay it off)

3 things to do if interest rate cuts are delayed, according to experts

Why you should split your funds between a CD and high-yield savings account now

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We'll Be Right Back!

Who’s eligible for debt relief under the new plan?

What are the challenges to implementing this new debt relief plan, which loans are eligible for forgiveness , how will forgiving interest help borrowers, what steps should student loan borrowers take in the meantime, where can i apply for the new forgiveness plan , if i’m not eligible for this plan, what other options do i have, will biden’s new student loan forgiveness plan cancel my debt.

Maybe. The new rules are complicated, so we talked to an expert to answer your top questions.

Dashia Milden

Dashia is a staff editor for CNET Money who covers all angles of personal finance, including credit cards and banking. From reviews to news coverage, she aims to help readers make more informed decisions about their money. Dashia was previously a staff writer at NextAdvisor, where she covered credit cards, taxes, banking B2B payments. She has also written about safety, home automation, technology and fintech.

Courtney Johnston

Senior Editor

Courtney Johnston is a senior editor leading the CNET Money team. Passionate about financial literacy and inclusion, she has a decade of experience as a freelance journalist covering policy, financial news, real estate and investing. A New Jersey native, she graduated with an M.A. in English Literature and Professional Writing from the University of Indianapolis, where she also worked as a graduate writing instructor.

CNET staff -- not advertisers, partners or business interests -- determine how we review the products and services we cover. If you buy through our links, we may get paid.

Key takeaways:

• On April 16, the Department of Education published a first draft of the White House’s newest student debt relief plan rules.
• The administration’s latest student loan forgiveness plan could wipe out balances for 25 million borrowers.
• If passed, millions could see their debt automatically cancelled as soon as this fall. It’s unclear yet if others will need to apply for the program.

Last week, the White House announced a new student debt relief plan that would clear outstanding balances for 25 million people if enacted. And yesterday, the Department of Education just released the first draft of the proposal rules, offering clarity on who might be eligible for debt cancellation.

The Biden administration has made several attempts to pass broad federal student loan forgiveness proposals over the past few years. And it’s been a challenging road.

After the White House’s first attempt at widespread loan relief was shot down in the Supreme Court last year, the administration implemented a new income-driven repayment plan, Saving on a Valuable Education or SAVE, that offers a chance at loan forgiveness after repaying your loans for 20 to 25 years. This plan has forgiven a total of $153 billion in student debt relief for nearly 4.3 million Americans to date, including another $7.4 billion in student loans canceled in April.

Its latest endeavor to help lower the student debt burden would erase balances for some borrowers and could decrease runaway interest charges for those who don’t qualify for full relief. 

“The new student loan proposals will provide full or partial financial relief to tens of millions of borrowers, especially borrowers who are experiencing financial distress,” said Mark Kantrowitz, a student financial aid expert and member of our CNET Money Expert Review Board . 

As someone still repaying student loans nearly ten years later, I wanted to find out the likelihood of this new plan being passed, who will qualify for forgiveness, and what steps (if any) borrowers should take now. I shared my burning questions with Kantrowitz, and here’s what I learned.

If passed, the administration’s latest debt relief plan could wipe out balances for millions of student loan borrowers. Here’s who it could benefit:

• Borrowers with loan balances that have grown significantly due to interest could see up to $20,000 of their interest balances canceled. Those enrolled in an income-driven repayment plan making below $120,000 a year ($240,000 for those married, filing jointly) could receive automatic forgiveness for the full amount their balance has increased due to interest.
• Borrowers with undergraduate federal student loans who began repaying 20 years ago could have their remaining debt forgiven.
• Borrowers with graduate federal student loans who began repaying 25 years ago could have their remaining debt forgiven.
• Borrowers with federal student loans who are eligible for loan forgiveness under SAVE or other programs like Public Service Loan Forgiveness or Teacher Loan Forgiveness could see their balances canceled, even if they haven’t enrolled in the qualifying programs.
• Borrowers who experienced financial hardship or those who attended a school that lost federal funding might also be able to receive relief. The administration is drafting a rule for borrowers facing financial hardship in the coming months. 

Since the Biden administration’s first attempt at sweeping loan forgiveness was blocked, I know it’s likely that the latest plan will also face resistance.

“The new regulations for targeted forgiveness will become final this summer,” said Kantrowitz. But he expects them to be blocked -- maybe temporarily -- by the courts. 

“The main risk with President Biden’s new proposal is that it is likely to be subject to legal challenges for the same reasons as the original proposal for broad student loan forgiveness,” said Kantrowitz. The administration’s first attempt at widespread student debt relief was not authorized under the Higher Education Relief Opportunities for Students, or the HEROES Act . 

And it could face other obstacles. “It may also be subject to challenges under the Administrative Procedures Act based on claims that it is arbitrary, capricious and vague and an abuse of discretion,” said Kantrowitz. 

Even though some individual proposals have passed legal challenges, combining all of these proposals into a new plan could increase the chances that the courts will all block it, he added.

It’s too soon to tell what will happen, but expect a bumpy ride. The administration released its first draft of the rules today. The Department of Education will open a 30-day comment period tomorrow (April 17) to help finalize rules in time for relief in the fall. If the measure moves forward, the Biden administration expects more loan balances could be forgiven this fall. 

Most federal student loans, including qualifying undergraduate, graduate, student and parent loans, will be eligible for forgiveness under the new plan, said Kantrowitz. 

Some loans don’t qualify, like Federal Family Education Loans or FFEL. If you have one of these loans, you can consolidate them into a Direct loan to qualify for debt relief under an income-driven repayment plan or PSLF. You can do this by visiting Studentaid.gov and completing the steps for consolidation . 

Private student loans from banks and online lenders are not eligible for debt relief.

Many student loan borrowers have larger balances now than when they initially started repayment due to runaway interest. If this is the case for you, the new interest forgiveness plan could reduce your loan balance or eliminate it altogether.

According to the White House fact sheet , the plan could help create more financial stability for working families while addressing the debt that people of color face. 

The plans could eliminate accrued interest for 23 million borrowers and cancel debt for four million. Additionally, over 10 million borrowers will see relief of $5,000 or more. Black and Latino borrowers, who are more likely to see their student loan balances grow due to interest accumulation, will benefit most from the administration’s new propositions. 

Whether this new student loan debt relief plan will be passed is unclear. Until then, Kantrowitz recommends signing up for autopay to ensure you don’t miss any payments. You may also qualify for a 0.25% interest rate reduction when you sign up for autopay.

Claim the student loan interest deduction on your federal income tax return. The deduction excludes up to $2,500 in interest paid on federal and private student loans and saves you money on taxes. 

If you qualify for interest relief under the new plan, Kantrowitz said you can try to increase the amount of interest that will be forgiven by switching to an income-driven repayment plan. If you can’t afford payments, you can consider applying for deferment or forbearance if you meet the requirements.

Just make sure you understand how each of these steps could impact your existing loan balance. If you’re approved to make lower monthly payments or temporarily stop paying, your balance may increase due to interest. If the administration’s new debt relief isn’t successful, that could leave you with more to pay off.

If you can afford your current monthly payments but want to apply for an IDR to lower your payment and increase the interest that could be forgiven, it may make sense to contribute the difference to a high-yield savings account . 

For example, if you pay $350 per month toward your student loans and an IDR lowers your payment to $150, you could contribute the extra $200 to your savings. Then, if the plan is passed, you could be eligible for more interest forgiven. If not, you can move the funds from your savings to your student loan balance. Either way, you’ve also earned interest on your money in the meantime.

There isn’t an application for the Biden administration’s new debt relief program yet. And it’s currently unclear if you’ll need to apply or if adjustments to your loan balances will be automatic.

“The goal of the new regulations is to make forgiveness automatic so that no application is necessary,” said Kantrowitz. “However, some of the proposals do not seem to be amenable to automatic forgiveness and may require an application.” 

If you’re not eligible for full forgiveness or don’t qualify for aid under this latest student loan relief plan, you still have options. “Borrowers who are ineligible may be able to get some financial relief through the SAVE repayment plan, deferments and forbearances,” said Kantrowitz. 

Income-driven repayment plans, like SAVE, can help you lower your monthly student loan payment to a more affordable amount. If you still need to check to see if you’re eligible to save money with the SAVE program, you can explore different IDRs at StudentAid.gov .

If you can’t afford your monthly payment, whether you’re on an IDR or not, you can talk to your servicer about deferring your student loans. If you’re experiencing financial hardship, enrolling in school or enlisting in the military, deferring your loans allows you to stop paying your student loans. During deferment, interest will not continue accruing on qualifying loans like subsidized and Perkins loans. 

If you don’t qualify for deferment, you may qualify for forbearance, which allows you to stop making payments temporarily. However, interest will accrue while you’re not making payments, so your loan balance will grow. When your forbearance ends, you’ll resume making payments.

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Another 277,000 borrowers received student loan forgiveness last week. here’s how you can, too, 25 million americans could have student loan debt wiped out under biden’s latest plan, fafsa rollout delayed, leaving students in limbo. what to know about this year’s financial aid deadlines.

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How does debt forgiveness work and are you eligible?

Debt forgiveness offers relief, but it won’t fix all of your financial problems..

Justin Cupler

Contributing Writer at Tally

April 17, 2020

Debt can add up quickly, making it easy to get in over your head. And some debts can nail you unexpectedly, like a tax bill. While there are many options for repaying your debt, there are some cases where paying it in full will put you in a financial bind. In these situations, debt forgiveness may help.

The debt collection process is not only stressful for you — it puts added stress on the creditor too. This is why some creditors prefer to settle your debt for less than you owe instead of going through the drawn-out collections process.

Below, we'll go through the different types of debt forgiveness and how to apply for them. But first, let's take a more in-depth look at what debt forgiveness is and how it works.

What is debt forgiveness?

Also called debt relief or debt cancelation, debt forgiveness is when a creditor or organization clears all or a portion of your debt. In some cases, the creditor will wipe the slate clean, but it’s often a third-party company or even the federal government that manages this.

Debt forgiveness is a compromise, and the benefits come at a cost. Aside from repaying a portion of your debt, you may have to pay a fee and can even get a negative hit to your credit score . Debt forgiveness is available for many types of debt, including student loans, taxes and even credit cards .

Federal student loan debt forgiveness

Student loans likely have some of the most robust loan forgiveness plans, but they are for federal loans only. A private student loan doesn't fall under the same rules. Below are some debt forgiveness options for federal student loans.

Income-driven repayment plans

There are a handful of income-driven repayment plans for federal student loans, and each one has small variations to meet different borrower needs.

Each plan's monthly payment is determined by your discretionary income, which is your annual income minus 100% or 150% of the poverty line for your family and state, as determined by the U.S. Department of Health and Human Services .

These income-driven repayment plans are as follows:

Revised Pay As You Earn (REPAYE)

Pay As You Earn (PAYE)

Income-Based Repayment (IBR)

Income-Contingent Repayment (ICR)

The REPAYE, PAYE and IBR plans use the difference between your family's annual income and 150% of the poverty line to determine your discretionary income. Your loan payment under these three plans is 10% of your discretionary income unless you opt for the IBR and took out your loans before July 1, 2014. In this case, your payments would be 15% of your discretionary income.

For example, if you’re a family of four living in one of the 48 contiguous states with a household income of $50,000 per year, the 2020 poverty line is $26,200 per year. Multiply $26,200 by 150% to get $39,300, then subtract $39,300 from $50,000 to get a discretionary income of $10,700. At 10%, your loan payment would be $1,070, which amounts to $89.16 per month. If you fall under the 15% guideline, the payment would be $1,605, which is $133.75 per month. 

Keep in mind, you must resubmit your income and household size each year, so the payment will fluctuate as your income and household size change. 

With the ICR plan, your discretionary income is your family's annual income minus 100% of the poverty guidelines. Its payment calculation is also different — it's either 20% of your discretionary income or what you'd pay on a fixed-payment, income-adjusted 12-year repayment plan, whichever is lower.

Using the same household information as above, in an ICR plan you would subtract $26,200 from $50,000 to get $23,800 in discretionary income. Multiply that by 20%, and you get payments of $4,760, which comes out to $396.67 per month. As in the previous example, this payment will change with your income and household size.

Depending on the plan you choose and other variables, the federal government will forgive any remaining balance after 20-25 years.

You can apply for these debt-forgiveness repayment plans online.

Job-based student loan forgiveness

There are two types of job-based student loan forgiveness programs. Like the income-driven forgiveness repayment plans, these plans require you to pay back at least some of the loan.

The most robust plan is the Public Service Loan Forgiveness Plan, which applies to nonpolitical government workers at the state, federal or local level, or anyone working with a Section 501(c)(3) nonprofit organization for at least 30 hours per week while repaying their loans.

After making 120 qualifying loan payments – on time and for the full amount on the bill – the federal government will forgive any remaining balance.

The Teacher Loan Forgiveness Program is a little stricter. It requires a teacher to have at least a bachelor's degree and state certification, and work full-time for five consecutive academic years in a school or education service agency serving low-income students. Teachers can find a list of these low-income schools and agencies online .

The amount of forgiveness also varies after five years of employment as a teacher. Science, math and special education teachers can receive $17,500 in loan forgiveness, while all other teachers receive $5,000 in loan forgiveness.

Private student loan forgiveness

Private student loans don't qualify for the range of repayment and forgiveness plans that federal loans do. Still, you're not necessarily stuck trying to manage a loan you can't afford.

As with any debt, the Consumer Finance Protection Board (CFPB) recommends reaching out to your private student loan servicer and explaining your situation. The company may have a debt forgiveness program available.

If the servicer offers no debt forgiveness plans,  the CFPB advises attempting to get a graduated or extended repayment plan to ease the burden. The CFPB even offers a sample letter to send to your loan servicer.

Credit card debt forgiveness

While credit card companies aren't necessarily in the market to help you diminish your debt, there are instances when they can be helpful, namely through debt settlement programs.

To get a debt settlement, you must contact a representative of your credit card provider and tell them you aren't able to repay your debt and would like to discuss a debt settlement. The credit card company will generally offer one of two responses: "Sorry, we don't do debt settlements on current accounts" or "I'll transfer you to a rep who can help with that."

If they say yes to working something out, great. You can speak with the representative and see what they can offer you. However, if they say no (and you have been timely with your credit card payments), you can stop making payments and take a negative mark on your credit to qualify for a settlement. Otherwise, you can find a different path.

If the credit card company isn’t willing to offer a debt settlement, you might think contacting a third-party debt relief company will help. But the CFPB strongly recommends against working with debt settlement companies due to high fees, unfulfillable promises and the fact they’ll likely get the same response you did and direct you to leave your credit cards unpaid.

The big issue with credit card settlements is it generally results in the credit card company leaving two negative marks on your credit. First, the credit card company will likely  cancel the account , which negatively impacts your credit score by reducing your credit history length and available credit. Second, the credit card account will show you settled it for less than the full amount owed, which can also harm your credit score .

If you’re unable to make your monthly credit card payments, you can also consider options like the  Tally line of credit . Tally's line of credit may offer you a lower-interest line of credit to reduce your monthly payment and help you pay off your debt faster.

You can also try  debt consolidation to lower your monthly payments, but this can come with high fees and strict credit score requirements.

Tax debt forgiveness

Many people see Tax Day as the time when they find out how much money the government owes them, but there are plenty of people who are stuck owing the government. In some cases, these owed taxes are unexpected, leaving the person indebted to the IRS.

Much like other federal debts, the IRS offers a forgiveness program to help taxpayers settle their debt without paying the full balance. This program is called the  offer in compromise (OIC).

The IRS looks at your ability to pay, income, expenses and asset equity when determining your eligibility for an OIC. If it sees that paying your taxes in full will put you in financial hardship and you meet all other requirements, it will approve an OIC that represents the most the IRS "can expect to collect within a reasonable period of time."

There's a long list of qualifiers that determine eligibility for an OIC, but the IRS  online pre-qualifier helps streamline the process. Once you complete the pre-qualifier, you’ll know if you meet all the requirements to apply for the offer in compromise.

If you qualify, you’ll  download the Form 656 Booklet and follow the instructions to formally apply. The application process includes filling out forms 656 and 433-A or 433-B (all the required forms are in the Form 656 Booklet) and paying a $186 application fee. You can have the application fee waived if you qualify for a low-income certification, which you can determine on page two of form 656 in the booklet.

Offer in compromise amount

The IRS gives little guidance online as to how much an offer in compromise should be, leading to some confusion. The only requirement the IRS mentions is that the offer must be higher than $0. The forms 433-A and 433-B clear this up with a simple calculation that adds the equity in your assets and your remaining future income (income minus expenses) to determine your OIC amount. If you receive a rejection, you can submit a new offer without repaying the application fee.

Paying the OIC

When paying the offer in compromise, you have two options: a lump sum or payment plan.

In the lump sum plan, you must pay 20% of your OIC amount upfront then pay the remaining balance within five months.

With the payment plan you pay over the course of 6-24 months. If you choose the payment plan, you must include the first payment with your application and continue making the payments while the IRS considers your offer.

Once you complete the payment plan or pay off the lump sum, the IRS will forgive any remaining tax debt balance.

Tax considerations for debt forgiveness

When you have certain debts forgiven, the IRS may view the amount the company or organization forgives as income, which can result in a higher tax bill for you the following year. In the case of tax debt, the IRS doesn’t view the forgiven balance as income. For credit cards and student loans, however, the results are mixed.

Credit cards

If a credit card company accepts a debt settlement offer and forgives $600 or more in debt, the company must file a 1099-C with the IRS. This form notifies the IRS, which considers forgiven debt as income. As such, you’ll have to pay income taxes on this amount when you file your taxes the following year.

Student loans

There are two types of student loan forgiveness. If your loan servicer forgives the loan based on the type of job you have, such as the Public Service Loan Forgiveness or Teacher Loan Forgiveness plans, the IRS doesn't consider it income.

However, if an income-based or income-contingent repayment plan wiped away $600 or more in student loan debt after 20-25 years, the IRS considers that forgiven debt as income. This income will be added to your next year's tax returns and may increase the taxes you owe.

Find out if you qualify

While debt can feel overwhelming, there are ways to calm the storm and steer your personal finances in the right direction. Debt consolidation, a line of credit or even debt forgiveness are just a few options that can help. If the latter seems to be the most practical option for you, now is the time to reach out to your creditors or the IRS and get back on track.

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A Gen Xer who got $250,000 in student loans forgiven said he can now finally start saving for retirement — and consider his dream of studying in India

• Joel Lambdin, 49, received $250,000 in student-loan forgiveness in January.
• It's a result of the Education Department's one-time account adjustments.
• Lambdin said the relief would allow him to save for retirement and consider long-term dreams.

Joel Lambdin finished graduate school in 1998 — but as a professional musician, he was hardly making enough money to pay off his student loans and other bills.

So Lambdin, now 49, said his only option to make ends meet was to put his student loans in forbearance — in which he was not making payments but interest was still accumulating .

"It was just so that I could subsist, so that I could survive," Lambdin told Business Insider. "With the hope that at some point, I would be making enough money that I would be able to take them out of forbearance and start paying them down."

But he grew to realize that the only way he could make a significant dent in his student loans was by switching careers. He didn't want to do that because he loved working in music, so he decided to keep his larger student loan in forbearance and begin paying off his smaller loan with a lower monthly payment.

He continued making those payments until the pandemic pause on student-loan payments , at which point he and his wife started making a plan of action to tackle the larger debt once the pause ended. That led them to discover the Education Department's initiative allowing some borrowers a one-time account adjustment . It lets the department evaluate borrowers' accounts and update payment progress toward forgiveness on income-driven repayment plans and Public Service Loan Forgiveness, including any payments made during a forbearance period.

That account adjustment led to a letter Lambdin received on January 31, reviewed by BI, from his student-loan servicer Aidvantage. It said: "Congratulations! The Biden-Harris Administration has forgiven your federal student loan(s) listed below with Aidvantage in full."

For Lambdin, that letter meant his $249,255 outstanding student-loan balance was effectively wiped out.

"It had started to feel like my fate was being decided for me by the cold hand of finance," Lambdin said, "and that was a weight that I didn't realize was there until it wasn't there."

He added: "The feeling was much more like putting down a backpack that was really full of books that you got used to. And then you put it down, and you're like, 'Oh, man, that feels so much better.' It's more like that, rather than sort of a jump-for-joy kind of situation."

While Lambdin is still working to determine what exactly the relief will mean for him and his wife, he said, discussing retirement is "a much more present conversation now" because contributing to savings is viable after the relief. He can also begin to look into buying a home.

Related stories

The Education Department continues to cancel student debt through its one-time account adjustments, a process it plans to complete this summer. Most recently, the department wiped out $7.4 billion in student debt for 277,000 borrowers , some of whom benefited from the adjustments.

Beyond financial goals, Lambdin said the relief was also allowing him the freedom to pursue some of his long-term dreams, including taking a sabbatical to study with his meditation teacher in India.

"It's something that I wouldn't have been able to even consider doing if we had to pay off student loans, but without them, it's something that I can really seriously consider doing," he said. "And so those are the kinds of things that I think get really lost in the monetary side of the conversation about debt relief."

'I've been really lucky'

While Lambdin said he felt as though he earned the relief given his decades of payments, he recognized that it's not that easy for many other borrowers.

For example, as BI has previously reported , some borrowers who might qualify for relief through different repayment programs may not have gotten it yet because of paperwork backlogs and administrative errors. On top of that, funding for federal student-loan servicers is strained — meaning many borrowers face hourslong hold times and cannot get clear answers from customer service regarding their payment progress.

"There are some real horror stories out there, and I've been really lucky in that I haven't experienced the kinds of shenanigans that other people have experienced," Lambdin said. "So I actually feel very lucky that things have transpired the way they have."

Some of those horror stories include inaccurate payment projections and delayed billing statements . When it comes to student-loan forgiveness, some borrowers told BI that their servicer made a mistake with the forgiveness , reinstating their payments months later.

The Education Department has said it's aware of the challenges borrowers face and has established an accountability framework to punish servicers when they fail to fulfill their contractual obligations.

The department is also in the process of crafting its new plan for student-loan forgiveness — it recently released the draft text of the rules , which included relief for borrowers with unpaid interest and those who have been in repayment for at least 20 years.

As for Lambdin, he's still figuring out how to approach life without student debt hanging over his head. But now he can consider various options, and he can thank the loan forgiveness for that freedom.

"There's a certain amount of waiting for the other shoe to drop because it's not that I don't trust that it's happening but just that the debt has been with me for so long, and then it's not there," Lambdin said. "And it's something that I think really takes some getting used to."

Watch: Biden announces who can have $10,000 erased in student loans

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When it comes to the debt forgiveness rules, is all really forgiven?

The recent economic downturn may bring forth unexpected tax issues. As creditors become more inclined to forgive or settle debt without full or even partial repayment, more corporations may find that they are settling debt for less than the principal amount. While this may initially seem like a favourable result for debtor corporations, there are tax implications that must be considered. Specifically, debtor corporations need to consider the impact of the debt forgiveness rules so they can plan accordingly.

A recap of the rules

Sections 80 through 80.04 of Canada’s Income Tax Act (ITA) contain a complex and comprehensive set of rules on the treatment of debt forgiveness.

In simple terms, the debt forgiveness rules apply when a “commercial debt obligation” has been settled for an amount that is less than the full amount owing (i.e., the “forgiven amount”). A commercial debt obligation is generally a debt obligation on which interest, if charged, is deductible in computing income. In other words, if interest on the particular debt is not deductible, the debt forgiveness provisions do not apply.

When reviewing the applicability of the debt forgiveness rules, it is therefore necessary to consider the relevant statutory provisions and jurisprudence regarding the deductibility of interest under paragraph 20(1)(c) of the ITA. A full review of interest deductibility is beyond the scope of this article, but the key takeaway is that the debt does not need to be interest-bearing to meet the criteria of a commercial debt obligation. If this is the case, the forgiven amount is applied to reduce certain corporate tax attributes in a specified order, with the remaining unapplied amount included in the debtor’s income.

These tax attributes, presented in the order in which they can be reduced, are as follows:

• Reductions of prior year losses under subsection 80(3)—i.e., non-capital losses net of allowable business investment losses (ABIL), farm losses, and restricted farm losses;
• Reductions of ABILs and gross capital losses (grossed up by paragraph 80(2)(d)) under subsection 80(4));
• Reductions in undepreciated capital cost (UCC) of depreciable property under subsection 80(5);
• Reductions in resource expenditures under subsection 80(8);
• Reductions in the adjusted cost base of capital properties under subsection 80(9);
• Reductions in the adjusted cost base of certain shares where the debtor is the specified shareholder under subsection 80(10); and
• Reductions in the adjusted cost bases of certain shares, debts, and partnership interests under subsection 80(11).

If a residual amount remains, 50% of any forgiven amount will be included in the debtor’s income, as per subsection 80(13) of the ITA.

Minimizing the impact of the forgiven amount

The following practical strategies can minimize the forgiven amount under the debt forgiveness rules:

Transfer the forgiven amount

If there is a residual forgiven amount remaining after applying subsections 80(3) to (10), section 80.04 allows the debtor corporation to transfer the balance of the forgiven amount to reduce the tax attributes of any related corporation or partnership, referred to as an “eligible transferee.”

Transfer depreciable property to a subsidiary

Piggybacking off the section 80.04 designation, consider a scenario in which a debtor corporation has a forgiven amount of $100 and does not want the application of subsection 80(5) to grind down its UCC pool. By chance, the debtor corporation has a sister company (“LossCo”) with non-capital losses of $100 that can’t be used, and an amalgamation isn’t feasible for commercial reasons. The debtor corporation can incorporate a subsidiary (“SubCo”) and transfer the depreciable property to SubCo before applying the debt forgiveness rules. By doing this, the debtor corporation can make a section 80.04 election and assign the forgiven amount to LossCo without triggering a reduction to SubCo’s UCC pool.

The reason for this, as noted in the rules recap, is that the debtor corporation must apply the forgiven amount to the tax attributes in subsection 80(3) to 80(10) before a section 80.04 election can be made. If the debtor corporation decides to retain its depreciable property, the section 80.04 election will not be available.

Preserve discretionary deductions

The debt forgiveness rules dictate that the forgiven amount must first be applied to reduce non-capital and capital loss balances, respectively. The debtor corporation may then designate an amount to be a reduction of UCC or a capital cost balance. Since it is a designation, this reduction is not mandatory. Instead, the debtor corporation may simply take the subsection 80(13) income inclusion of 50% of the unapplied forgiven amount. The latter choice can be advantageous when, instead of grinding the tax attributes by 100% of the forgiven amount, the debtor corporation can take a discretionary deduction, such as a capital cost allowance, to reduce the subsection 80(13) 50% income inclusion and thereby preserve the remaining tax attributes for future years.

Note that if the creditor attempts to transfer the commercial debt obligation to a related person of the debtor for less than 80% of its principal amount, the debt may be considered a “parked obligation,” as defined in subsection 80.01(7) of the ITA, to which the debt forgiveness rules would apply. 

Relieving provisions from the income inclusion rule

If none of the above planning opportunities are applicable, the debtor corporation may want to consider the relieving provisions under sections 61.3 and 61.4 of the ITA to help contend with subsection 80(13)’s income inclusion rule.

Section 61.3 provides a deduction for certain insolvent corporations that effectively limits the debt forgiveness income inclusion rule under subsection 80(13) to twice the fair market value of the corporation’s net assets at the end of the year. In its technical notes to the provision, the Department of Finance explains that—assuming a tax rate of 50% or less—this rule ensures that the corporation’s liabilities will not exceed the fair market value of its assets at year-end . An insolvent corporation will most likely have a net asset value of nil, resulting in a full deduction against the subsection 80(13) income inclusion rule.

Note that relief under section 61.3 may apply to both resident corporations and non-resident corporations as long as they are not exempt from Part I tax. In addition, when claiming the section 61.3 deduction, debtor corporations should consider the anti-avoidance provision in subsection 61.3(3), as this provision restricts the deduction when: a) properties are transferred within a 12-month period (during a given year); and b) it is reasonable to assume that one of the reasons for the transfer was to increase the deduction under Section 61.3.

For solvent corporations, section 61.4 allows for a reserve to defer the subsection 80(13) income inclusion over a maximum five-year period (a minimum balance of 20% per year). This is available to a corporation or trust resident in Canada, or a non-resident person carrying on a business through a fixed place of business in Canada, during the year.

The takeaway

The debt forgiveness rules are extensive and quite complex, and we are likely to see them being applied more regularly as British Columbians continue to deal with the economic impact of the COVID-19 pandemic. Thankfully, there are many planning strategies and opportunities available to minimize the income inclusion to the debtor corporation.

Steve Youn, CPA, CA, is a tax partner with DMCL LLP in Vancouver. He specializes in personal and corporate tax services (including private companies and trusts & estates) and inbound cross-border tax structures.

Originally published in the March/April 2021 issue of CPABC in Focus .

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Insight Article

Debt and taxes: restructuring, settlement, assignment considerations.

Often a distressed target business will have significant liabilities on its balance sheet including bank debt, shareholder loans or other related party debts.

Transactions frequently result in payouts, settlements or restructuring of the target’s debt and could have undesirable tax consequences to the target if not structured with timing and responsibility for tax exposures in mind.

Debt forgiveness

Section 80 of the Canadian  Income Tax Act (Act)  governs the tax treatment of situations where a ‘commercial debt obligation’ is forgiven. A debt is forgiven when it is wholly or partially settled for an amount less than the outstanding principal balance, which generally includes any accrued but unpaid interest amounts.

A ‘commercial debt obligation’ for tax purposes is generally an obligation incurred for the purposes of gaining or producing income and on which interest charged would be deductible and therefore could include a noninterest bearing loan.

The difference between the settlement value and the principal amount is referred to as the ‘forgiven amount’ and will reduce various tax attribute pools of the debtor in the following order:

• Noncapital losses and farm losses
• Net-capital losses
• The capital cost and undepreciated capital cost (UCC) of depreciable property as designated by the debtor in prescribed form
• Resource expenditures
• Adjusted cost base (ACB) of capital properties
• ACB of certain shares where the debtor is specified shareholder
• ACB of certain shares, debts and partnership interests

For a debtor other than a partnership, where the forgiven amount cannot be fully applied to the above tax attributes and no exceptions apply; 50 per cent of the remainder is included in income.

Settlement for less than principal

The simplest type of debt forgiveness occurs where a company settles its obligations, using cash or other assets, for less than the outstanding principal amount. In the context of a transaction, this may occur where the agreement requires the target to be ‘debt-free’ on acquisition and often, there are insufficient assets available to satisfy all amounts owing. While it may be difficult to settle arm’s length debt at less than the principal amount, non-arm’s length debt or shareholder debts may frequently be settled at less than face value resulting in debt forgiveness.

Debt replacement

Replacement, restructuring or refinancing may give rise to debt forgiveness in certain circumstances such as when the principal amount of the ‘new’ debt is less than the principal amount of the ‘old’ debt.

In a transaction context, it is not uncommon for a target business to be recapitalized or existing debt to be replaced with new borrowing. By comparing the principal amount of the old and new debts rather than their fair market values (FMV), the rules effectively allow for replacement of debt, facilitating changes in the repayment and commercial terms as well as the interest rates without triggering the debt forgiveness rules. It is important to consider any tax implications, including debt forgiveness, particularly if the principal amounts differ.

Debt to equity conversions

In some instances, creditors will opt to convert their debt into equity of the debtor corporation. In contrast to debt-for-debt exchanges, debt to equity conversions are valued for debt forgiveness purposes at the FMV of the shares issued.

Often in the context of a private company transaction, shareholders or other non-arm’s length creditors will convert all, or a portion of debt to equity prior to sale. Accordingly, a forgiveness event may occur where the FMV of the equity issued is less than the principal amount of the debt settled. Acquisition of control implications should be considered, and where a non-resident is involved, the thin capitalization rules and withholding tax may apply.

Distressed preferred shares can be issued to lenders only where the company is in receivership, bankruptcy or is expected to default on its obligations. These shares may be issued in settlement of debt without the application of the forgiveness rules, but must be structured properly to avoid inadvertent tax consequences.

Debt parking

Where a non-arm’s length party acquires a commercial debt obligation from the debtor for less than 80 per cent of its principal amount, the debt may become a ‘parked obligation’ giving rise to a debt forgiveness event. Originally, this legislation was intended to capture situations where arm’s length debt was acquired by a party related to the debtor at a discount and with no intent to settle. The application in practice is much broader and can extend to transactions where a buyer assumes the position of creditor in the target business at a discounted value, regardless of the buyer’s intention to settle.

Planning for debt forgiveness

In most instances, distressed businesses will have beneficial tax attributes such as operating losses and capital losses the purchaser is expecting to inherit. The impact of acquisition of control and debt forgiveness rules should be considered as part of the tax due diligence process to ensure attributes are utilized prior to closing when required.

If a forgiven amount still remains after reducing the tax attributes, an insolvency deduction may be available, limiting the income inclusion to two times the fair market value of net assets. This deduction may be of limited use in a transaction context where a positive net asset value can readily be determined due to value attributed to unrecorded assets such as goodwill.

Any remaining unapplied forgiven amount may be eligible for inclusion in income over a five-year period by claiming a reserve or transferred to a related corporation once all tax attributes of the debtor have been exhausted. In a transaction context this may permit sellers to transfer the forgiven amounts pre-closing to a related company outside of the transaction perimeter.

Key takeaway

Consideration of a target’s existing debt is common to almost every private company acquisition. The impact of any transaction or structuring on those liabilities should be considered as part of the tax due diligence process. Working with a tax professional well-versed in M&A transactions will ensure any tax consequences can be appropriately addressed in the most efficient manner.

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• GAINS & LOSSES

Taxing the Transfer of Debts Between Debtors and Creditors

• C Corporation Income Taxation
• NOL & Other Tax Attributes
• Individual Income Taxation

T he frequent transfer of cash between closely held businesses and their owners is very common. If the owner works in the business, the transfer is likely to be either a salary to a shareholder/employee or a Sec. 707(c) guaranteed payment to a partner. Alternatively, the transfer may be a loan. As long as the true substance of the transaction is a loan, it will be respected for tax purposes. 1

The cash flow is not exclusively from the businesses to the owner. Many owners prefer to capitalize their closely held business with a combination of equity and debt. Once again, these loans will be respected and not reclassified as equity if they are bona fide loans.

In the normal course of business, these loans are repaid. The receipt of the repayment will be tax free except to the extent it is interest. However, in difficult economic conditions, many of these loans are not repaid. To the extent that the creditor cancels the obligation, the debtor has cancellation of debt (COD) income under Sec. 61(a)(12). This income is taxable unless the taxpayer qualifies for an exclusion under Sec. 108. In other cases, the debt is transferred between the parties either as an independent transaction or part of a larger one. This article reviews these transactions.

Two basic types of transfers have created significant tax issues. In the first, the debtor transfers the debt to the creditor. If the debtor is the owner of a business and the business is a creditor, the transfer appears to be a contribution. If the business is the debtor and the owner is the creditor, the transfer can be a distribution, liquidation, or reorganization. The other type of transfer is from the creditor to the debtor. Again, the transaction can take the form of a contribution if the creditor is the owner, or it can take the form of a distribution, liquidation, or reorganization if the creditor is the business.

Debtor-to-Creditor Transfers

Corporations.

The two seminal cases that established the framework for analyzing the transfer of a debt obligation from a debtor to a creditor are Kniffen 2 and Edwards Motor Transit Co. 3 Arthur Kniffen ran a sole proprietorship and owned a corporation. The sole proprietorship borrowed money from the corporation. For valid business reasons, Kniffen transferred the assets and liabili ties of the proprietorship to the corporation in exchange for stock of the corporation, thereby transferring a debt from the debtor to the creditor. The transaction met the requirements of Sec. 351.

The government argued that the transfer of the debt to the creditor was in fact a discharge or cancellation of the debt (a single step), which should have been treated as the receipt of boot under Sec. 351(b) and taxed currently. The taxpayer argued that the transfer was an assumption of the debt and, based on Sec. 357(a), should not be treated as boot.

The Tax Court acknowledged that the debt was canceled by operation of law. However, it did not accept the government’s argument as to the structure of the transaction. Instead, it determined that two separate steps occurred. First, the corporation assumed the debt. This assumption was covered by Sec. 357(a). After the assumption, the interests of the debtor and creditor merged and the debt was extinguished. Since the transfer was not for tax avoidance purposes, Sec. 357(b) did not apply. The result was a tax-free Sec. 351 transaction, except to the extent that the assumed debt exceeded the bases of the assets transferred, resulting in gain under Sec. 357(c). This decision established the separation of the debt transfer from its extinguishment.

Edwards Motor Transit Co. cites, and is considered to have adopted, the approach in Kniffen . For valid business reasons, the owners of Edwards created The Susquehanna Co., a holding company, and transferred Edwards’ stock to it under Sec. 351. Susquehanna borrowed money from Edwards to meet certain financial obligations. To eliminate problems that arose from having a holding company owning the stock of an operating company, the owners merged Susquehanna into Edwards under Sec. 368(a)(1)(A). The government acknowledged that the basic transaction was a nontaxable merger. However, the government wanted the company to recognize income as a result of the cancellation or forgiveness of the debt. The Tax Court ruled for the taxpayer, on the grounds that the debt transfer (from debtor to creditor) was not a cancellation of the debt. The ruling cited Kniffen as authority for this conclusion.

On its surface, Edwards Motor Transit affirmed the decision and reasoning in Kniffen . The Tax Court stated, “The transfer by the parent corporation of its assets to Edwards [its subsidiary] . . . constituted payment of the outstanding liabilities . . . just as surely as if Susquehanna had made payment in cash.” This statement relied on both Kniffen and Estate of Gilmore. 4 In Gilmore , a liquidating corporation transferred a receivable to its shareholder who happened to be the debtor. In that case, the court ruled the transaction was an asset transfer and not a forgiveness of debt. The court based its conclusion in large part on the fact that no actual cancellation of the debt occurred.

The statement in Edwards Motor Transit quoted above, however, is inapposite to the conclusion in Kniffen . A payment is not a transfer and assumption of a liability. Since Susquehanna was deemed to have used assets to repay the debt, the Tax Court should have required Susquehanna to recognize gain to the extent that the value of the assets used to repay the debt exceeded their bases. The conclusions in Kniffen and Edwards are consistent only in their holdings that these debt transfers were not cancellations of debts that would result in COD income. In Kniffen, the court ruled that the debt was assumed and then extinguished. In Edwards, the court ruled that the extinguishment of the debt constituted repayment.

It is possible that the Tax Court reached the correct outcome in Edwards Motor Transit but for the wrong reason. In Rev. Rul 72-464, 5 a debtor corporation merged into the creditor corporation in a tax-free A reorganization under Sec. 368(a)(1)(A). The ruling concluded that the debtor corporation did not recognize any gain or loss on the extinguishment of the debt within the acquiring corporation. General Counsel Memorandum (GCM) 34902 6 provided the detailed analysis behind the conclusion.

The GCM cited both Kniffen and Edwards 7 and adopted their underlying rationale. Specifically, it concluded that the basic transaction (the reorganization) results in a transfer of the debt to the acquiring corporation. It is after the transfer that the debt is extinguished by the statutory merger of interests. The transfer is an assumption of debt, which is nontaxable under Sec. 357(a). Therefore, the transferor (debtor corporation) recognizes no gain or loss.

This is exactly what happened in Ed wards . The debt was assumed, not repaid. Therefore, the Tax Court should have reached the conclusion that the transaction was nontaxable under Sec. 357(a) and not have relied on the questionable authority of Estate of Gilmore 8 or concluded that the debt was repaid.

Liquidations

The transactions discussed up to this point have been either tax-free corporate formations (Sec. 351) or tax-free reorganizations (Sec. 361). In a different transaction that is likely to occur, the creditor/shareholder liquidates the debtor corporation.

If the transaction is not between a parent and its subsidiary, taxability is determined by Secs. 331 and 336. Prior to 1986, the outcome might have been determined by Kniffen and Edwards . With the repeal that year of the General Utilities 9 doctrine (tax-free corporate property distributions) and the enactment of current Sec. 336, the outcome is straightforward. Under Sec. 336, the debtor corporation that is liquidated recognizes its gains and losses. Whether the liquidated corporation is treated as using assets to satisfy a debt requiring the recognition of gain or is treated as distributing assets in a taxable transaction under Sec. 336, all the gains and losses are recognized.

The taxation of the shareholder is a little more complex. First, the shareholder must determine how much it received in exchange for the stock. The most reasonable answer is that the shareholder received the value of the assets minus any debt assumed and minus the face amount of the debt owed to it by the liquidated corporation. This amount is used to determine the gain or loss that results from the hypothetical sale of stock under Sec. 331. Second, the shareholder must determine what was received for the debt, whether assets or the debt itself. The amount received in payment of the liquidated corporation’s debt is a nontaxable return of capital. If the shareholder is deemed to have received the debt itself, then the debt is merged out of existence. The basis of all the assets received should be their fair market value (FMV) under either Sec. 334(a) or general basis rules.

If the liquidated corporation is a subsidiary of the creditor/shareholder, the results change. Under Sec. 337, a subsidiary recognizes neither gain nor loss on the transfer of its assets in liquidation to an 80% distributee (parent). Sec. 337(b) expands this rule to include distributions in payment of debts owed to the parent corporation. Therefore, the subsidiary/debtor does not recognize any gain or loss.

The parent corporation (creditor) recognizes no gain or loss on the liquidation of its subsidiary under Sec. 332. The basis of the transferred property in the hands of the parent is carryover basis. 10 This carry­over basis rule also applies to property received as payment of debt if the subsidiary does not recognize gain or loss on the repayment. 11 In other words, the gain or loss is postponed until the assets are disposed of by the parent corporation.

One important exception to the nonrecognition rule is applied to the parent corporation. Under Regs. Sec. 1.332-7, if the parent’s basis in the debt is different from the face amount of the debt, the parent recognizes the realized gain or loss (face amount minus basis) that results from the repayment. Since this regulation does not mention any exception to the rules of Sec. 334(b)(1), the parent corporation is required to use carryover basis for all the assets received without adjustment for any gain or loss recognized on the debt.

This discussion of liquidations assumes that the liquidated corporation is solvent. If it is insolvent, the answer changes. The transaction cannot qualify under Secs. 332 and 337. The shareholder is not treated as receiving any property in exchange for stock; therefore, a loss is allowed under Sec. 165(g). The taxation of the debt depends on the amount, if any, received by the shareholder as a result of the debt.

Partnerships

The taxation of debt transfers involving partnerships is determined, in large part, by Secs. 731, 752, and 707(a)(2)(B). Specifically, the taxation of transfers by debtor partners to the creditor/partnership is determined by the disguised sale rules of Sec. 707(a)(2)(B), whereas transfers by debtor partnerships to a creditor/partner fall under Secs. 731 and 752.

Sec. 707(a)(2)(B) provides that a transfer of property by a partner to a partnership and a related transfer of cash or property to the partner is treated as a sale of property. The regulations specify the extent to which the partnership’s assumption of liabilities from the partner is treated as the distribution of the sale price.

Regs. Sec. 1.707-5 divides assumed liabilities into either qualified liabilities or unqualified liabilities. A qualified liability 12 is one that:

• Was incurred more than two years before the assumption;
• Was incurred within two years of the assumption, but was not incurred in anticipation of the assumption;
• Was allocated to a capital expenditure related to the property transferred to the partnership under Temp. Regs. Sec. 1.163-8T; or
• Was incurred in the ordinary course of business in which it was used, but only if all the material assets of that trade or business are transferred to the partnership.

The amount of qualified recourse liabilities is limited to the FMV of the transferred property reduced by senior liabilities. Any additional recourse liabilities are treated as nonqualified debt.

If a transfer of property is not otherwise treated as part of a sale, the partnership’s assumption of a qualified liability in connection with a transfer of property is not treated as part of a sale. The assumption of nonqualified liabilities is treated as sale proceeds to the extent that the assumed liability exceeds the transferring partner’s share of that liability (as determined under Sec. 752) immediately after the partnership assumes the liability. If no money or other consideration is transferred to the partner by the partnership in the transaction, the assumption of qualified liabilities in a transaction treated as a sale is also treated as sales proceeds to the extent of the transferring partner’s share of that liability immediately after the partnership assumes the liability. 13 Following the assumption of the liability, the interests of the debtor and creditor merge, thereby extinguishing the debt. The result is that generally the full amount of these assumed liabilities are part of the sale proceeds. 14

The assumed liabilities that are not treated as sale proceeds still fall under Sec. 752. Since the transaction results in a reduction of the transferor’s personal liabilities, the taxpayer is deemed to have received a cash distribution equal to the amount of the debt assumed under Sec. 752(b). Given that the debt is immediately extinguished, no amount is allocated to any partner. The end result is that the transferor must recognize gain if the liability transferred exceeds the transferor’s outside basis before the transaction, increased by the basis of any asset transferred to the partnership as part of the transaction.

A partnership may have borrowed money from a partner and then engaged in a transaction that transfers the debt to the creditor/partner. The first question is whether the initial transaction is a loan or capital contribution. Sec. 707(a) permits loans by partners to partnerships. The evaluation of the transaction is similar to one to determine whether a shareholder has loaned money to a corporation or made a capital contribution. The factors laid out in Sec. 385 and Notice 94-47 15 should be considered in this analysis.

Assuming the debt is real and it alone is transferred to the creditor/partner, the outcome is straightforward. The partner is treated as having made a cash contribution to the partnership under Sec. 752(a) to the extent that the amount of debt exceeds the amount allocated to the partner under the Sec. 752 regulations. If part of the debt is allocated to other partners, these other partners are treated as receiving a deemed cash distribution.

If the transfer is part of a larger transaction, then the analysis is a little more complex. The transfer of the other assets is governed by Secs. 737, 731, and 751. Sec. 737 requires a partner to recognize gain if, during the prior seven years, the partner had contributed property with built-in gain to the partnership and the current FMV of the distributed property exceeds the partner’s outside basis. The partner is treated as recognizing gain in an amount equal to the lesser of (1) the excess (if any) of the FMV of property (other than money) received in the distribution over the adjusted basis of such partner’s interest in the partnership immediately before the distribution reduced (but not below zero) by the amount of money received in the distribution, or (2) the net precontribution gain of the partner. The outside basis is increased by the amount of the deemed contribution because the partner assumed a partnership liability. After any gain under Sec. 737 is determined, the general distribution rules of Secs. 731 and 751(b) apply to the transaction. In effect, the transfer to a creditor/partner of a partnership debt owed to the partner is treated the same as any liability assumed by the partner. The extinguishment of the debt should not result in additional tax consequences.

Creditor-to-Debtor Transfers

In addition to debtor-to-creditor transfers, there are creditor-to-debtor transfers. The outcome of these transactions is determined by the two-step analysis in Kniffen . The creditor is treated as having transferred an asset to the debtor/owner. After the transfer, the interests of the debtor and creditor merge, resulting in the extinguishment of the debt. This extinguishment is generally nontaxable since the basis of the debt and the face amount are equal. 16 The result changes if the basis in the hands of the creditor and the adjusted issue price of the debtor are not equal. 17

One of the initial pieces of guidance that addressed this question was Rev. Rul. 72-464. 18 In this ruling, the debt was transferred in a nontaxable transaction. Consequently, the recipient (the debtor) had a carryover basis in the debt. Since this basis was less than the face amount, gain equal to the difference was recognized. This ruling did not explain the reasoning behind the gain recognition or the potential impact if the value of the debt was different from its basis. 19 These items were addressed in Rev. Rul. 93-7. 20

Rev. Rul. 93-7 analyzed a transaction between a partnership and a partner, here designated P and A , respectively. A was a 50% partner. This percentage allowed A to not be a related party to P under Sec. 707(b). P also had no Sec. 751 assets, and A had no share of P ’s liabilities under Sec. 752. These were excluded because they did not affect the reasoning behind the taxation of debt transfers. A issued a debt with a face amount of $100 for $100. P acquired the debt for $100. When the debt was worth $90, it was distributed to A in complete redemption of its interest, which had an FMV of $90 and outside basis of $25. In other words, a creditor/partnership distributed debt to the debtor/partner.

The debt was an asset, a receivable, in the hands of P . When it was distributed to A , P determined its taxation under Sec. 731(b), which provides that no gain or loss is recognized by a partnership on the distribution of property. The application of Sec. 731(b) in this transaction followed directly from Kniffen , which treated the transfer of a debt as a separate transaction from any extinguishment that follows the transfer. Under Sec. 732, A ’s basis in the transferred debt was $25. 21

The basis rules of Sec. 732 assume that a built-in gain or loss on distributed property is realized and recognized when the recipient disposes of the property. In this situation, the distributed debt was extinguished, and therefore no future event would generate taxable gain or loss. Consequently, this extinguishment became a taxable event. In this specific case, A recognized gain of $65 ($90 FMV – $25 basis) and COD income of $10 ($100 face − $90 FMV.) The ruling did not spell out the reasoning for the recognition of both gain and COD income. It is the correct outcome based on Regs. Sec. 1.1001-2. Under that regulation, when property is used to satisfy a recourse obligation, the debtor has gain equal to the difference between the value of the property and its basis, and COD income equal to the difference between the amount of debt and the value of the property used as settlement. The distributed debt is property at the time of the distribution, and the rules of Regs. Sec. 1.1001-2 should apply.

In Rev. Rul. 93-7, the value of the debt was less than the face amount. A debt’s value could exceed its face amount. In that case, the revenue ruling indicated, a deduction for the excess value may be available to the partner as a result of the deemed merger. In Letter Ruling 201105016, 22 the IRS ruled that a taxpayer was entitled to a deduction when it reacquired its debt at a premium as part of a restructuring plan. Rev. Rul. 93-7 cited Regs. Sec. 1.163-4(c)(1), and Letter Ruling 201105016 cited Regs. Sec. 1.163-7(c). Both regulations state that the reacquisition of debt at a premium results in deductible interest expense equal to the repurchase amount minus the adjusted issue price. Regs. Sec. 1.163-4(c)(1) applies to corporate taxpayers, while Regs. Sec. 1.163-7(c) expanded this treatment to all taxpayers. Based on these regulations and the treatment of the distribution as an acquisition of a debt, an interest expense deduction should be permitted when the value exceeds the amount of debt, whereas COD income is recognized when the value is less than the amount of the debt.

In Rev. Rul. 93-7, the partnership was the creditor, and the debt was transferred to a debtor/partner. The reverse transaction can occur, in which a creditor/partner transfers debt to the debtor/partnership in exchange for a capital or profits interest. Sec. 721 applies to the creditor/partner. Therefore, no gain or loss is recognized. However, Sec. 108(e)(8)(B) applies to the debtor/partnership. Sec. 108(e)(8)(B) provides that the partnership recognizes COD income equal to the excess of the debt canceled over the value of the interest received by the creditor. This income is allocated to the partners that owned interests immediately before the transfer. The partnership does not recognize gain or loss (other than the COD income) as a result of this transaction. 23 The value of the interest generally is determined by the liquidation value of the interest received. 24 If the creditor receives a profits interest, the liquidation value is zero, and therefore the partnership recognizes COD income equal to the amount of debt transferred.

Corporate Transactions

Debt transfers between corporations and shareholders are just as likely as transfers between partners and partnerships. If the transferor is a shareholder or becomes a shareholder as a result of the transaction, Secs. 1032, 118, and 351 provide basic nontaxability. However, Sec. 108 overrules these sections in certain cases.

If the shareholder transfers the debt to the corporation as a contribution to capital, Sec. 108(e)(6) may result in the recognition of COD income by the corporation. Under Sec. 108(e)(6), the corporation is treated as having satisfied the indebtedness with an amount of money equal to the shareholder’s adjusted basis in the indebtedness. Therefore, the corporation has COD income amount equal to the excess of the face amount of the debt over the transferor’s basis in the debt immediately prior to the transfer. In most cases, the face and basis are equal, and no COD income is recognized. If the transfer is in exchange for stock, Sec. 108(e)(8)(A) provides that the corporation is treated as having satisfied the indebtedness with an amount of money equal to the FMV of the stock. Therefore, the corporation recognizes COD income equal to the excess of the face value of the debt over the value of the stock received. In many cases, the value of the stock is less than the debt canceled, and therefore COD income is recognized. Sec. 351 provides that 80% creditor/shareholders recognize neither gain nor loss if the debt is evidenced by a security. If Sec. 351 does not apply, the creditor/shareholder may be able to claim a loss or bad-debt deduction.

Rev. Rul. 2004-79 25 provides a detailed analysis of the transfer of debt from a creditor corporation to a debtor shareholder. The analysis is similar to the one for partnership distributions covered by Rev. Rul. 93-7, discussed previously.

Modifying the facts of Rev. Rul. 2004-79, assume that a shareholder borrows money from his corporation. The face amount of the debt is $1,000, and the issue price is $920. The original issue discount (OID) of $80 is amortized by both the corporation and the shareholder. At a time when the adjusted issue price and basis are $950 but the FMV is only $925, the corporation distributes the debt to the shareholder as a dividend.

From the corporation’s point of view, this is a property dividend. Rev. Rul. 2004- 79 cites Rev. Rul. 93-7, but it could just as easily have cited Kniffen . As a property dividend, the transaction’s taxa tion to the corporation is governed by Sec. 311. Since the value in the revenue ruling was less than the basis, the corporation recognized no gain or loss. If the value had appreciated, the corporation would have recognized gain equal to the appreciation.

The shareholder receives a taxable dividend equal to the value of the debt; consequently, the debt has a basis equal to its FMV of $925. Since the debt is automatically extinguished, the shareholder is treated as having satisfied an obligation in the amount of $950 with a payment of $925. Therefore, the shareholder must recognize $25 of COD income.

A second fact pattern in the revenue ruling is the same, except the value of the distributed debt is $1,005. Under these facts, the shareholder would be entitled to an interest expense deduction under Regs. Sec. 1.163-4 or 1.163-7 in the amount of $55 ($1,005 − $950). In other words, the shareholder is deemed to have reacquired its own debt for a payment equal to the basis that the distributed debt obtains in the transaction.

The conclusions of Rev. Rul. 2004-79 are consistent with those in Rev. Rul. 93-7. They follow the reasoning of Kniffen .

Another transaction that could occur involving shareholder debt is a liquidation of the corporation, resulting in a distribution of the debt to the debtor/shareholder. The results should be similar to those in Rev. Rul. 2004-79. The corporation that distributes the debt is taxed under Sec. 336. Therefore, the corporation recognizes gain or loss depending on the basis of the debt and its FMV. This is the same result as in the dividend case, except that the loss is recognized under Sec. 336 instead of being denied under Sec. 311. The shareholder’s basis in the debt is its FMV under Sec. 334(a). The shareholder recognizes COD income or interest expense, depending on whether the basis is less than or greater than the adjusted issue price of the debt. These results flow from the regulations under Secs. 61 and 163 and are consistent with the conclusions in the above revenue rulings.

The results change slightly if the liquidation qualifies under Secs. 332 and 337. The IRS discussed these results in Chief Counsel Advice 200040009. 26 Sec. 332 shields the parent from recognition of income on the receipt of the debt. Sec. 337 shields the liquidating corporation from recognizing gain or loss on the transfer of the debt to its parent corporation. The basis is carryover basis under Sec. 334(b). Then, because the debt is extinguished, the parent recognizes either COD income or interest expense on the extinguishment of the debt. As in the prior revenue rulings and Kniffen , the extinguishment has to be a taxable event because the elimination of the carryover basis prevents the parent corporation from having a taxable transaction in the future involving this debt. These results are consistent with prior decisions.

The results discussed for a parent/subsidiary liquidation should also apply if the debtor/corporation acquires a corporation that owns its debt in a nontaxable asset reorganization. In this case, Sec. 361 replaces Secs. 332 and 337. The extinguishment of the debt is a separate transaction that should result in recognition of income or expense.

Acquired Debt

So far, this article has discussed transactions between the debtor and creditor. Now it turns to how the holder of the debt acquired it. In many cases, the holder acquired the debt directly from the debtor, and the acquisition is nontaxable. In other situations, the debt is outstanding and in the hands of an unrelated party. The holder acquires the debt from this unrelated party. In these cases, Sec. 108(e)(4) may create COD income.

Under Sec. 61, if a debtor reacquires its debt for less than its adjusted issue price, the debtor has COD income. Sec. 108(e)(4) expands on this rule: If a party related to the debtor acquires the debt, the debtor is treated as acquiring the debt, with the resulting COD income recognized. Related parties are defined in Secs. 267(b) and 707(b)(1).

The regulations provide that the acquisition can be either direct or indirect. A direct acquisition is one by a person related to the debtor at the time the debt is acquired. 27 An indirect acquisition occurs when the debtor acquires the holder of the debt instrument, where the holder of the debt acquired it in anticipation of becoming related to the debtor. 28 The determination of whether the holder acquired the debt in anticipation of becoming related is based on all the facts and circumstances. 29 However, if the holder acquires the debt within six months before the holder becomes related to the debtor, the acquisition by the holder is deemed to be in anticipation of becoming related to the debtor. 30

In the case of a direct acquisition, the amount of COD income is equal to the adjusted issue price minus the basis of the debt in the hands of the related party. In the case of indirect acquisitions, the calculation depends on whether the debt is acquired within six months of being acquired. 31 If the holder acquired the debt within six months of being acquired, the COD income is calculated as if it were a direct acquisition. If the holder acquired the debt more than six months before being acquired, the COD income is equal to the adjusted issue price minus the FMV of the debt instrument on the date that the holder is acquired.

When a debtor reacquires its own debt, in addition to reporting COD income, the debtor has the debt extinguished as a result of the merger of interests. When a related party acquires the debt, the debtor has COD income, but the debt remains outstanding. In these cases, the debtor is treated as issuing a new debt instrument immediately following the recognition of the COD income for an amount equal to the amount used to calculate the COD income (adjusted basis or FMV 32 ). If this issue price is less than the stated redemption price at maturity of the debt (as defined in Sec. 1273(a)(2), the difference is OID that is subject to the amortization rules of Sec. 1272.

Rev. Rul. 2004-79 provides a simple example of this transaction. In the ruling, a parent corporation, P , issued $10 million of debt for $10 million. After issuance, S , a subsidiary of P , purchased the debt for $9.5 million. Under Regs. Sec. 1.108-2(f), P had to recognize $500,000 of COD income ($10 million face − $9.5 million basis to S ). After this recognition, P was treated as having issued the debt to S for $9.5 million. Therefore, $500,000 of OID was amortizable by P and S . If S later transfers the debt to P , the previously discussed rules determine the taxation of the transfer using S ’s basis ($9.5 million + amortized OID).

Secs. 61 and 108(e)(4) apply only if the debt is acquired for less than the adjusted issue price. If the acquisition price is greater than the adjusted issue price, the acquiring party treats this excess as premium and amortizes it, thereby reducing the amount of interest income recognized by the holder.

Installment Obligations

An installment obligation differs from other obligations in that the holder recognizes income when cash is collected in payment of the obligation. The rules describing the taxation of installment obligations were rewritten as part of the Installment Sales Revision Act of 1980, P.L. 96-471. Under old Sec. 453(d) (new Sec. 453B(a)), if the holder of an installment obligation distributes, transmits, or disposes of the obligation, the taxpayer is required to recognize gain or loss equal to the difference between the basis in the obligation and the FMV of the obligation. There is an exception to this rule for distributions in liquidation of a subsidiary that are exempt from taxation under Sec. 337.

Prior to the Code revision, the regulations permitted the transfer of installment obligations without gain recognition if the transaction was covered by either Sec. 721 or 351. 33 Although the regulations have not been revised for the Code change, the IRS continues to treat Secs. 721 and 351 as overriding the gain recognition provision. 34

If the transaction results in transfer of the obligation either from the creditor to the debtor or from the debtor to the creditor, the tax result changes. The seminal case is Jack Ammann Photogrammetric Engineers, Inc. 35 In it, the taxpayer created a corporation to which he contributed $100,000 in return for 78% of the corporation’s stock. He then sold his photogrammetry business to the corporation for $817,031. He received $100,000 cash and a note for $717,031. He reported the sale under the installment method. When he was still owed $540,223 on the note, he transferred it to the corporation for stock of the corporation worth $540,223. He reported this as a disposition under Sec. 453(d) and recognized the deferred gain. Later, he filed a claim for refund, arguing that Sec. 351 prevented recognition of the deferred gain. After allowing the refund, the IRS assessed a deficiency against the corporation, arguing that the corporation came under Sec. 453(d). The corporation argued that, under Sec. 1032, it was not taxable. The Tax Court ruled for the IRS.

The Fifth Circuit reversed the decision. The underlying reasoning was that the disposition by the shareholder and the extinguishment of the debt in the hands of the corporation were separate transactions. The extinguishment did not fall under Sec. 453(d). The court indicated that the IRS should have assessed the tax against the shareholder.

Following this case, the IRS issued Rev. Rul. 73-423. 36 In this ruling, a shareholder transferred an installment obligation from Corporation X back to the corporation in a transaction described in Sec. 351. The ruling concluded that the transfer was a satisfaction of the installment agreement at other than face value under Sec. 453(d)(1)(A) and that the shareholder was required to recognize gain without regard to Sec. 351. The corporation had no gain or loss under Sec. 1032 and Ammann .

Sec. 453(d) is now Sec. 453B(a), and the rule has not changed. Therefore, if a creditor transfers an installment obligation to the debtor in an otherwise tax-free transaction, the obligation is treated as satisfied at other than its face value, and the creditor is required to recognize gain or loss as discussed in Rev. Rul. 73-423. 37

New Sec. 453B(f) covers transactions in which installment obligations become unenforceable. This section covers the extinguishment of an installment debt through a merger of the rights of a debtor and creditor. The Code treats these transactions as dispositions of the obligation with gain or loss recognized. When the debtor and creditor are related, the disposition is at FMV but no less than the face amount.

If the debtor of an installment obligation engages in a transaction in which the creditor assumes the debt, the results are consistent with those of transactions involving obligations other than installment notes. The debtor is deemed to have received cash equal to the amount of the debt. This is fully taxable unless exempted by Sec. 357, 721, or a similar provision. The creditor falls under Sec. 453B(f), with the extinguishment treated as a taxable disposition of the obligation for its FMV (which for related parties is no less than the face amount).

Business entities often incur debts to their owners, and, conversely, the owners incur liabilities to their business entities. In numerous transactions these obligations are canceled for consideration other than simple repayment of the debt. Based on Kniffen , these transactions are treated as a transfer of consideration followed by an extinguishment of the debt. If a shareholder’s debt to his or her controlled corporation is transferred to that corporation along with assets, the transaction may be tax free under Secs. 351 and 357(a). If a shareholder/creditor receives the related corporate debt in a distribution or liquidation, Sec. 311 or 336 determines the corporation’s taxation.

The cancellation of a partner’s debt to the partnership is generally governed by the distribution rules, including the constructive sale or compensation rules of Sec. 707(a)(2). When a partner cancels the partnership’s debt, the partner has made a contribution to capital. This can have consequences to all partners since the total liabilities are decreased and the partners’ bases are decreased under Sec. 752.

In most cases the merger of debtor and creditor interests is nontaxable. However, if the basis of the debt or receivable does not equal the face amount of the debt, income or loss is recognized. The exact amount and character of the income or loss depends on factors discussed in this article. It is important for the tax adviser to identify those cases in which the debt transfer is not tax free.

1 Invalid loans to shareholders have been reclassified as dividends.

2 Kniffen , 39 T.C. 553 (1962).

3 Edwards Motor Transit Co. , T.C. Memo. 1964-317.

4 Estate of Gilmore , 40 B.T.A. 945 (1939).

5 Rev. Rul. 72-464, 1972-2 C.B. 214.

6 GCM 34902 (6/8/72). The GCM also refers to Sec. 332, which will be dis cussed later.

7 As the GCM points out, by using Sec. 357(a), taxpayers could achieve the same outcome in C reorganizations.

8 See Chief Counsel Advice 200040009 (10/6/00), which suggests Estate of Gilmore ’s requirement of a formal cancellation of debt before COD income is recognized may no longer be valid.

9 General Utilities & Operating Co. v. Helvering , 296 U.S. 200 (1935).

10 Sec. 334(b)(1).

12 Regs. Sec. 1.707-5(a)(6).

13 If the partnership transfers money or other consideration in the transaction, the amount treated as sales proceeds may be limited under Regs. Sec. 1.707-5(a)(5)(i)(B).

14 Under Regs. Sec. 1.707-5(a)(3)(ii), a partner’s share of liabilities is reduced by liabilities assumed that are anticipated to be reduced. Based on Kniffen and Edwards , the reduction will be anticipated.

15 Notice 94-47, 1994-1 C.B. 357.

16 See, e.g., IRS Letter Ruling 8825048 (3/23/88).

17 The transaction that gives rise to the difference and the taxation that results are discussed later.

18 Rev. Rul. 72-464, 1972-2 C.B. 214. Although this is a debtor-to-creditor transfer, the result is the same.

19 See GCM 34902 (6/8/72).

20 Rev. Rul. 93-7, 1993-1 C.B. 125.

21 If the partnership makes a Sec. 754 election, the partnership has a Sec. 734 adjustment of $75 ($100 inside basis – $25 basis after distribution).

22 IRS Letter Ruling 201105016 (2/4/11).

23 Regs. Sec. 1.108-8, effective Nov. 17, 2011.

24 See the Regs. Sec. 1.108-8(b)(2) safe-harbor rule.

25 Rev. Rul. 2004-79, 2004-2 C.B. 106.

26 CCA 200040009 (10/6/00).

27 Regs. Sec. 1.108-2(b).

28 Regs. Sec. 1.108-2(c)(1).

29 Regs. Sec. 1.108-2(c)(2).

30 Regs. Sec. 1.108-2(c)(3).

31 Regs. Secs. 1.108-2(f)(1) and (2).

32 Regs. Sec. 1.108-2(g).

33 Regs. Sec. 1.453-9(c)(2).

34 See IRS Letter Rulings 8824044 (3/22/88) and 8425042 (3/19/84).

35 Jack Ammann Photogrammetric Engineers, Inc. , 341 F.2d 466 (5th Cir. 1965), rev’g 39 T.C. 500 (1962).

36 Rev. Rul. 73-423, 1973-2 C.B. 161.

37 Although this revenue ruling involved a corporation, the IRS believes the same rule applies to partnerships. Treasury is currently working on a revision of the regulations to clarify the results. See the preamble to Regs. Sec. 1.108-8, T.D. 9557 (11/17/11).

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