(Image: Shutterstock)

Student loan borrowers who have been deceived by their colleges got some good news this week.

The IRS granted relief to any borrower whose federal or private loan was discharged by the Department of Education as a result of the DOE’s closed school or borrower defense discharge process or due to a legal case settlement. Those borrowers won’t have to recognize the forgiven loan amount as gross income, which is the usual treatment for discharged loans.

In addition, the House of Representatives passed a resolution that would prevent the DOE, under Secretary Betsy DeVos, from implementing a new borrower defense rule that would slash the number of eligible borrowers who could qualify for loan forgiveness. The vote was 231 to 180. Six Republicans voted for the measure.

The IRS decision affects loans used to finance attendance at nonprofit and for-profit schools except those owned by Corinthian Colleges or the American Career Institute, since those borrowers previously received IRS relief.

Sen. Elizabeth Warren, D-Mass., who promotes student loan forgiveness in her presidential campaign and fought for the tax exemption for Corinthian Colleges students in 2015, praised the IRS decision for expanding the tax exemption “to protect more students from additional hardship.”

Defrauded students will have a harder time getting future loans discharged under a new DOE borrower defense rule set to take effect July 1 for loans made on or after that date. The House resolution would prevent that, but the Senate would have to follow suit. The rule could also be  delayed by a court challenge, which has happened with other rules proposed by the current DOE.

The new rule requires that a borrower apply for loan forgiveness within three years of leaving college, which would eliminate hundreds of thousands of existing claims, according to Beth Stein, special advisor to The Institute for College Access & Success (TICAS).

If the rule were in effect today, borrowers who attended The University of Phoenix between October 2012 and December 2016, lured by ads promising future job opportunities at large companies, would not have their loans forgiven, even though the Federal Trade Commission recently canceled $141 million in student debt and fined the school $191 million because of those practices.

The new borrower defense rule would also require borrowers to demonstrate intent of a school to deceive and financial harm beyond their indebtedness, said Stein. In addition, borrowers would be required to file individual separate claims rather than group claims, which would make it impossible for those who couldn’t afford a lawyer. In the end, borrowers would receive relief on only about 3% of the value of their claims, according to TICAS, which used DOE data in its calculation.

“Students who have been misled about taking loans deserve to have their loans forgiven,” says Stein. “It’s no different than buying a car lemon.”

Under the current borrower defense rule, which was developed by the Obama administration and took effect in 2016, about 48,000 student borrowers have had their loans forgiven. The median amount forgiven was near $11,000 and the total amount $534.7 million. Another 224,000 forgiveness applications are pending, and the DOE has granted zero or very few claims since June 2018.

When the DOE processes those pending claims, it intends to use a new formula that will compare a student’s earnings to the median earnings of graduates who attended a comparable school. If the earnings from the claimant’s school are lower than the median for a similar  program at comparable schools, but higher than two standard deviations from that median, the relief will be partial, between 25% and 75% of money owed.

Despite those stats and the pending new borrower defense rule and formula, Mark Kantrowitz, publisher and vice president of research at savingforcollege.com, recommends that borrowers subjected to misleading school conduct file defense repayment claims but not expect a resolution anytime soon. In theory, any application submitted before new regulations take effect should also be processed under the old rules, according to Kantrowitz.

— Related on ThinkAdvisor: