On March 18, 2012 the IRS released the Publication 970, Tax Benefits for Education for 2011 returns. Unlike in previous editions, the “Law school LRAP” is no longer listed as being tax free. According to the revised p970 edition for the tax year 2011 LRAP funds are taxable income unless for services in the health care profession as defined by the IRS p970 pages 36 and 37.
We believe this speaks to the availability of the exclusion under § 108(f)(4), which addresses LRAP programs as such and is restricted as stated, and that it does not speak to the availability of the exclusion under § 108(f)(1), which provides a separate exclusion for discharge of indebtedness that covers public interest employment more generally. Under the LRAP program, funds are loaned to a participant to assist with debt repayment and then this loan is discharged. Thus there is an argument that the exclusion in § 108(f)(1) applies. We are aware of no ruling or other statement by the IRS that the exclusion under § 108(f)(1) does not apply. But neither are we aware of clear authority that it does apply. Rev. Rul. 2008-34 is authority that § 108(f)(1) exclusion does apply to an LRAP program but is not clear authority.
If you do report the LRAP forgivable loan as income you should be able to deduct the amount of the benefit used to pay interest under § 221 though the deduction is subject to a cap.
Since there is discussion within the law school community based on IRC § 108(f)(2) that the LRAP forgivable loan should not be taxable, we recommend that you consult with a tax accountant for further advice.