Bankruptcy Court finds Income Based Repayment of student loans Unrealistic

On Jun 24, 2015, Michael Abney became a student loan hero when he filed his own adversary proceeding with the United States Bankruptcy Court of the Western District of Missouri.

The judge in this case decided that Abney’s federal student loans should be discharged tax free in bankruptcy, giving him a chance in the future to save for retirement and be able to live something of a better life.

In deciding if the loans were discharged, the judge looked at the totality of the circumstances the debtor was facing and was critical of income based repayment programs that the Department of Education says can help everyone.

Chief Bankruptcy Judge Arthur Federman was extremely dismissive of the Department of Education position that Abney’s loans should not be discharged because they have an income based repayment program in place to give him a $0 monthly payment.

Chief Bankruptcy Judge Arthur Federman stated “In determining how much weight to give to eligibility for IBRP, a court, contrary to the Department’s position, must be mindful of both the likelihood of a debtor making significant payments under the IBRP, and also of the additional hardships which may be imposed by these programs. As stated, interest and other charges would continue to accrue while the Debtor participated in IBRP, meaning that the total debt would be increasing. The overhang of such debt could well impact not only the Debtor’s access to credit over the 25-year IBRP period, but could also affect future employment opportunities and access to housing. And, decades of mounting indebtedness, even with a zero or minimal payment amount, can impose a substantial emotional burden as well. Indeed, in the Debtor’s case, the evidence showed that he has already suffered emotionally from his ongoing debt struggles and was in fact hospitalized in part because of it. Furthermore, borrowers who default while in an IBRP program lose eligibility. For someone with the Debtor’s income, and of his age, an inability to make one month’s payment over a 25-year year period is highly likely, given the possibility of medical conditions leading to additional expenses and loss of income, as well as other short-term financial emergencies encountered by those with nothing to fall back on.

And, even if the Debtor were able to navigate the 25-year program without a misstep, he could well then be faced with a significant tax debt when the debt is forgiven. To explain, discharge of a debt in bankruptcy is not itself a taxable event. However, forgiveness of a student loan at the end of the IBRP period is taxable in the same way as forgiveness of any other debt outside bankruptcy. That is, to the extent a debtor’s assets exceed liabilities after the forgiveness, the forgiven debt is taxable income. Thus, if the Debtor were able over the next 25 years to timely pay his IBRP payments, as well as pay his child support and other expenses, and to somehow accumulate reserves to fall back on for retirement or otherwise, he would then be rewarded with a tax bill based on the amount of principal, interest and other charges owed to the Department at the time of forgiveness, when the Debtor is likely to be at least 65 years old. In contrast, discharge of his student loans in bankruptcy would give the Debtor the opportunity to use his fresh start to support his children and improve his financial situation before he is too old to do so. While “the mere possibility of tax consequences at the expiration of the 25-year repayment period is not dispositive of the issue of whether the [IBRP] represents a viable avenue for repayment of the student loan debt,”