Qualified education loans and the dischargeability of student loans in bankruptcy

Transcription

1 Qualified education loans and the dischargeability of student loans in bankruptcy By Stanley Love Tate III

2 Copyright Licensed under the Creative Commons Attribution Non-Commercial Share Alike 3.0 License. Because as J Cole says on Note to Self, You was inspired by the world; allow the world to be inspired by your shit and to use your shit.

3 This shit is highly sophisticated. I just make it loos easy Rick Ross

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5 Qualified education loans and the dischargeability of student loans in bankruptcy Over the years, Congress has subjected more and more loans to the Bankruptcy Code s undue hardship discharge limitation, which is found at 11 U.S.C. 523(a)(8). Despite the broadening of this limitation, there are loans that section fails to protect. Usually these loans are private and are made in a way that they fail to fall within 523(a)(8)(B) s catch-all provision. About the catch-all provision While 523(a)(8)(A) protects government loans, subsection (B) protects any other loan from discharge if it s a qualified education loan. What s a qualified education loan As 523(a)(8)(B) states, we have to look to 221(d)(1) of the Internal Revenue Code to see how qualified education loan is defined. That section defines a qualified education loan as any indebtedness a 1

6 taxpayer incurs solely to pay qualified higher education expenses. What s meant by solely By way of an example in contrast, the Treasury Department regulations implementing 221(d)(1) explain what s meant by the phrase solely to pay qualified higher education expenses. Here s that example: MIXED USE LOANS John signs a promissory note for a loan secured by his personal residence. John will use part of the loan proceeds to improve his home and the rest to pay his wife s qualified higher education expenses. Because John got the loan not solely to pay qualified higher education expenses, the loan isn t a qualified education loan. 26 C.F.R (e)(4) ex. 6. Mixed use loans aren t qualified education loans Using the Treasury Department s example, cash advances, revolving credit lines, and credit card debt are qualified education loans only if the indebtedness was incurred solely to pay for qualifying higher education expenses. See 26 C.F.R (e)(3)(i); 64 Fed. Reg ( Accordingly, mixed use loans are not qualified education loans. Similarly, revolving lines of credit (e.g., credit card debt) generally are not qualified education loans, unless the borrower uses the line of credit solely to pay qualified higher education expenses. ) 2

7 More limits on qualified education loan There are three other hurdles the loan must meet to be a qualified expense. 1. The qualified expenses must have been incurred at the same time the indebtedness was incurred; 2. The qualified expenses must have been paid within a reasonable period before or after the indebtedness was incurred; and 3. The qualified expenses must have been attributable to education an eligible student received. 26 U.S.C. 221(d)(1)(A) (C). So what are qualified higher education expenses The Internal Revenue Code defines qualified higher education expenses as the cost of attendance as defined in 472 of the Higher Education Act at an eligible educational institution. Those expenses must be reduced by: o o The amount excluded from gross income under and The amount of any scholarship, allowance, or payment. What else counts as costs of attendance Cost of attendance includes tuition, fees, books, supplies, transportation, room and board, and miscellaneous personal expenses a student incurs while attending an institution at least half-time. See Busson-Sokolik v. Milwaukee Sch. of Eng'g (In re Busson-Sokolik), 635 F.3d 261 (7th Cir. 2011) (opining loan was educational if it was predicated on the borrower being a student 3

8 who needed financial support to get through school); but see Gamble v. Vanderbilt Univ. (In re Gamble), 388 B.R. 877 (Bankr. C.D. Ill. 2008) (post-bapcpa analysis holding student account charges for room and board not a loan and therefore dischargeable); Navarro v. Univ. of Redlands (In re Navarro), 284 B.R. 727 (Bankr. C.D. Cal. 2002) (pre-bapcpa, no loan existed because student merely signed an agreement acknowledging understanding of the tuition rate but didn t agree to pay in the future); Corso v. Walker (In re Walker), 439 B.R. 854 (Bankr. W.D. Pa. 2010), aff'd, 449 B.R. 838 (W.D. Pa. 2011) (obligation from debtor to her ex-spouse to satisfy parties' agreement to pay for daughter's college tuition was not an educational loan excepted from discharge under this provision); Gorosh v. Posner (In re Posner), 434 B.R. 800 (Bankr. E.D. Mich. 2010) (third-party who paid off debtor's student loans that third-party had co-signed wasn t a lender within this provision, and debt was discharged). What matters: the loan s purpose when it was obtained or how its proceeds were used Most courts focus on the loan s stated purpose when it was obtained. Rumer v. Amer. Educ. Services (In re Rumer), 469 B.R. 553, 562 (Bankr. M.D. Pa. 2012) citing In re Sokolik, 635 F.3d 261, 266 (7th Cir. 2011); Murphy v. Pennsylvania Higher Educ. Assistance Agency (In re Murphy), 282 F.3d 868, 870 (5th Cir. 2002). These courts focus on the substance of the transaction creating the obligation. The substance of the transaction test recognizes that 523(a)(8) s purpose is to exempt educational loans from discharge. Id. citing Tifty County Hospital v. Nies (In re Nies), 334 B.R. 495, 501 (Bankr. D. Mass. 2005). 4

9 So rather than trying to determine whether a computer purchased with loan money was used for schoolwork, personal use or some combination of both a court applying the substance of the transaction test need only ask whether the lender s agreement with the borrower was predicated on the borrower being a student who needed financial support to get through school. Id. quoting In re Sokolik, 635 F.3d. at 266. What s an eligible educational institution An eligible educational institution is any institution eligible to participate in a Title IV program. 26 U.S.C. 221(d)(2)(referring to 26 U.S.C. 25A(f)(2)(B)). Whose an eligible student A taxpayer is an eligible student if he is enrolled at least half-time at a Title IV institution and is seeking a degree, certificate, etc. See 26 U.S.C. 221(d)(3) (referencing 26 U.S.C. 25A(b)(3)(requiring the student fulfill the requirements of 484(a)(1) of the Higher Education Act of 1965 (20 U.S.C. 1091(a)(1)). Must a taxpayer have incurred the indebtedness for the loan to fall within the catch-all provision Yes. In 2009, a bankruptcy judge for the Middle District of Pennsylvania ruled that a loan extended to a nonresident alien didn t qualify as a student loan under 26 U.S.C. 221(d) and 11 U.S.C. 523(a)(8)(B). S.B.R. Investments v. Leblanc (In re Leblanc), 404 B.R Why not? Because the nonresident alien didn t file a tax return during the relevant period. Thus, she wasn t a taxpayer. 5

10 If a borrower refinances a loan that s a qualified education loan, does the new loan qualify as a qualified education loan A qualified education loan includes indebtedness a taxpayer used to refinance indebtedness that s a qualified education loan. 26 U.S.C. 221(d). So if a taxpayer refinances a qualified education loan and the new loan does nothing more than pay off and replace the qualified loan, the new loan will be a qualified education loan. And that will make the new loan nondischargeable under 523(a)(8). What about consolidation loans Similarly a consolidation loan won t be a qualified education unless the taxpayer incurred it solely to refinance two or more qualified education loans. 26 C.F.R (e)(3)(v) ( A qualified education loan includes indebtedness incurred solely to refinance a qualified education loan. A qualified education loan includes a single, consolidated indebtedness incurred solely to refinance. ) Does a loan even exist Over a decade ago, the Second Circuit articulated the standard for whether an extension of credit is a student loan for dischargeability purposes. Under the court s In re Renshaw decision, an extension of credit is a student loan for nondischargeability purposes if there s: 1. a contract, whereby 2. one party transfers money, goods, or services to another, and 6

11 3. the other party agrees to pay for such money, goods, or services at a later date; and 4. the contract was reached before or with the transfer. Cazenovia College v. Renshaw (In re Renshaw), 222 F.3d 82, (2d. Cir. 2000); see Chambers v. Manning (In re Chambers), 283 B.R. 913 (Bankr. N.D. Ill. 2002) (applying Renshaw test) aff d 348 F.3d 650 (7th Cir. 2003); see also In re Oliver, 499 B.R. 617 (Bankr. S.D. Ind. 2013)(stating a debt must be more than an extension of credit to be an educational loan); Barstow School v. Shojayi (In re Shojayi), 515 B.R. 329 (Bankr. D. Kan. 2014) (both parties must intend to create a loan); Boston Univ. v. Mehta (In re Mehta), 310 F.3d 308 (3rd Cir. 2002) (unilateral decision by student not to pay tuition when it came due doesn t result in a loan). o o Additional resources Limitations on exception to discharge of private student loans by Mark Kantrowitz, former publisher of FinAid.org Pomp and circumstances: The student loan crisis Who Borrows, How Much, Delinquency and Default Trends presented by Wenhua Di and others at an ABI conference. 7