If you borrow money in the form of a Parent PLUS Loan to pay for your child’s college education, then you may be wondering what happens to your loan if you die before repayment is complete. Here we will cover what happens to federal student loans in the event of disability or death.
Loan Discharge Due to Death
In the event of death, federal student loans are discharged, which means that the debtor and his or her dependents are absolved of all legal liability for repaying the debt. In the case of Parent PLUS Loans, the U.S. Department of Education permits loan dischargement if either the parent borrower or child recipient dies before repayment is complete.
Loan dischargement is not automatic in the event of death. The loan servicer must be provided with acceptable documentation to prove the death, which essentially means providing a death certificate. The death certificate can be the original, a certified copy, or a high-quality photocopy of either the original or certified copy. After the loan is formally discharged, the loan servicer adjusts the outstanding balance to zero, causing all further collection activities to cease.
Loan Discharge Due to Disability
The Department of Education also permits student loan discharge in the event of severe disability, which is known as Total and Permanent Disability (TPD). Eligible borrowers can have student loans discharged by completing a TPD discharge application and providing acceptable documentation from either a physician, the Social Security Administration, or the Department of Veterans Affairs. Loan dischargement due to TPD is handled by the loan servicer Nelnet on behalf of the Department of Education.
Just like with loans discharged due to death, loans discharged due to severe disability are essentially cancelled. Neither the disabled person nor his or her dependents are responsible for repaying the debt. (If the child recipient of a Parent PLUS Loan becomes severely disabled, the parent borrower must still repay the loan.) However, unlike in the event of death, loan dischargement due to disability is not granted immediately. Borrowers are subject to a three-year monitoring period, during which time they must provide documentation to Nelnet annually proving that their earnings from employment do not exceed state-specific poverty thresholds. In addition, during the monitoring period, borrowers may not obtain a new federal student loan or receive a disbursement from an existing loan. Disabled borrowers are not required to make any loan payments during the monitoring period, but loan dischargement is not formally granted until the monitoring period is complete. Failure to comply will all the requirements during the monitoring period can result in the reinstatement of a borrower’s repayment obligations.
Tax Implications of Loan Dischargement
The tax implications of loan dischargement have changed since the passage of the Tax Cuts and Jobs Act in 2017. Prior to the passage of this legislation, which took effect on January 1, 2018, discharged loan balances were treated as taxable income for the year that dischargement was granted. The Tax Cuts and Jobs Act removed this provision from the tax code, which is great news for borrowers. Disabled borrowers whose monitoring periods began in 2015 or later will not be subject to pay any income tax at the time when loan dischargement is formally granted. However, there is a slight catch - this form of tax relief is set to expire at the end of 2025. Unless an extension is granted or the tax relief is made permanent, disabled borrowers who begin the three-year monitoring period after 2022 will be required to pay income tax on discharged loan balances for the year when dischargement is formally granted. If you wish for tax relief from loan dischargements to become a permanent part of the tax code, then contact your representative.