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Discharging Student Loan Debt Through Bankruptcy – Choosing Your Path Forward in the Northern Kentucky Bankruptcy System

The following post is part of our Law Student Blog Writing Project, and is authored by Thomas Rovito, who is pursuing his Juris Doctorate at the Ohio State University.

One of the few things more frightening than end of term finals for students is crushing loan debt after undertaking an educational degree. But fear not. There are several bankruptcy discharge options for federal student loans, which may be altered by the type of bankruptcy, such as Chapter 7 or Chapter 13, or if the student has a specific level of disability.

Fortunately, there are several sources available online for free that can serve as guides on this topic. For instance, the Federal Student Aid Office of the U.S. Department of Education provides information on both loan forgiveness, cancellation, and discharge, as well as what happens to your federal student loan if you file for bankruptcy. Third-party legal websites, such as FindLaw, LegalZoom, and Nolo have various summaries on this topic. In addition, popular newspapers on finance, such as Forbes and NerdWallet, and education, like U.S. News & World Report, occasionally run articles on this topic. In addition, Lawrence & Associates has a proven track record on successfully resolving student loan debt legal issues for clients.

It is important at the forefront to look at the underlying statistics behind student loan debt discharge through bankruptcy for a realistic assessment. According to empirical research from the American Bankruptcy Law Journal, while “only 0.1 percent of student loan debtors who have filed for bankruptcy attempt to discharge their student loans,” the sample recorded in the journal also noted 39 percent discharged some of their student loan debt. But what legal mechanisms create these underlying statistics?

The first decision is whether to file bankruptcy under Chapter 7 (Liquidation) or Chapter 13 (Reorganization). As most government funded or guaranteed educational loans are non-dischargeable upon filing for bankruptcy, this status places an additional onus on the debtor to commence an adversary proceeding against the loan holder in bankruptcy court. See 11 U.S.C. § 523(a)(8).

The standard to discharge a debt is to display “undue hardship” before the bankruptcy court under the Brunner test. See Brunner v. New York State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987). This test, which has been accepted by most circuit courts, analyzes the facts of the case under the totality of the circumstances through three prongs: first, that payments on the student loan debt would cause the debtor to fall below a minimal standard of living, second, that persistent special circumstances prevent the debtor from paying off the loan, and third, that the debtor made good faith efforts to pay off the loan before filing for bankruptcy. As this test is relatively elastic, the outcome of the analysis will depend on the particular bankruptcy judge hearing the case and the underlying facts presented by debtor. If the bankruptcy court issues a discharge for the student loan debt, the discharge may be either partial or total; the court also has the authority to modify the interest rate for the student loan. If the bankruptcy court refuses to issue a discharge, the debtor may try to switch to a different repayment plan more consistent with the revenue and expenditures of the debtor.

One persistent special circumstance that materially impacts the bankruptcy discharge is a total and permanent disability discharge (TPD). TPD applies to William D. Ford Federal Direct Loans, Federal Family Education Loan Program Loans, and Federal Perkins Loan Program Loans. A debtor may prove disability to the U.S. Department of Education in one of three ways: veterans may submit paperwork from the U.S. Department of Veterans Affairs articulating unemployability from a service-related disability, recipients of Social Security Disability Insurance or Supplemental Security Income may submit paperwork from the Social Security Administration, or the debtor’s physician can submit paperwork that attests that the debtor is totally and permanently disabled. To view the TPD certification process, please consult https://www.disabilitydischarge.com/. If the U.S. Department of Education (through the Nelnet Total and Permanent Disability Servicer) finds a TPD, then they will instruct the loan collector to cease collection activities and return any payments after the finding of disability; on the other hand, if the U.S. Department of education does not find a TPD, then they will allow the loan collect to resume collection activities.

In the event a debtor obtains a TPD discharge, then they can no longer qualify for a Direct Loan, Perkins Loan, or TEACH Grant, unless the debtor “obtain[s] a certification from a physician that you are able to engage in substantial gainful activity,” and the debtor fills out a form “acknowledging that the new loan or TEACH Grant service obligation cannot be discharged in the future on the basis of any injury or illness present at the time the new loan or TEACH Grant is made, unless your condition substantially deteriorates so that you are again totally and permanently disabled.”

In addition, if the debtor was granted a TPD discharge through the filing of Social Security Administration paperwork or by the debtor’s physician (rather than through the U.S. Department of Veterans Affairs), the debtor will be subject to a three year monitoring period from the U.S. Department of Education, in which the former debtor must respond to inquiries from the U.S. Department of Education or provide notice to the U.S. Department of Education regarding earning thresholds, changes in address, and changes in status. If the former debtor fails to comply with these monitoring requirements, the debtor’s former student loan may be subject to reinstatement.

However, going through the TPD discharge process without also receiving a bankruptcy discharge on a student loan debt can raise tax implications. The U.S. Department of Education will send notice of any discharge of more than $600.00 to the Internal Revenue Service. The U.S. Department of Education will then send an IRS Form 1099-C to the former debtor recording the total amount of the discharge, which is considered as income for federal taxes (and for some states). However, the student loan bankruptcy process will not raise secondary taxation concerns, since a bankrupt debt cannot result in taxation for the forgiveness of a loan. By definition, bankrupt debts are not forgiven.

Thus, bankruptcy through Chapter 7 or Chapter 13 provides one possible avenue for discharging student loan debt through an adversary proceeding in which the bankruptcy court will likely apply the totality of the circumstances. In addition, a finding of Total and Permanent Disability also provides another avenue for student loan debt relief. It is also important to consider non-bankruptcy alternatives for student loan debt relief, such as repayment options, deferments, forbearance, forgiveness, cancellation, consolidation, or rehabilitation, which may preserve the debtor’s credit rating.

For more information, consult one of the experienced attorneys at Lawrence & Associates when choosing your path forward on discharging student loan debt. We’re Working Hard for the Working Class, and we want to help you!