Law schools that were concerned their students might have to pay taxes on loans that are forgiven received some reassurance from the Internal Revenue Service last month that students don’t have to claim the erased loans as income.

In a IRS revenue ruling, the agency clarified that the privilege of not claiming the erased loans as income doesn’t apply only to students who go into the nursing, medical and teaching professions, as suggested by a 2006 tax court opinion, but rather also includes the legal profession.

Specifically, the IRS clarification says that a law school graduate can work for a public interest or community service organization, a legal aid office or clinic, a prosecutor’s office, a public defender’s office or another local, state or federal government office and qualify for avoiding taxes on the loan write-off.

Confused and concerned

Some law schools were confused and concerned about the tax implications of their loan-repayment assistance programs, designed to give a financial benefit to students taking on lower-income jobs while carrying heavy law school debt, after a 2006 tax court summary opinion issued in Moloney v. Commissioner. That decision suggested that only students going into medical, nursing or teaching careers might be able to avoid income taxes on loans that are forgiven.

“The Moloney decision led to some confusion and for the purpose of clarification we published the revenue ruling,” said Craig Wojay, an IRS attorney adviser.

Many law schools had already proceeded with their programs under the assumption that the Moloney opinion did not make their students subject to the taxation. Wojay expects that the ruling will result in only “minor corrections” to programs.

Loyola Law School, Los Angeles is one that will now make some changes, said Ellen Aprill, a tax law professor and the school’s associate dean for academic programs.

Loyola, the Association of American Law Schools, the University of Virginia School of Law and Fordham University School of Law had all sent letters to the federal government seeking clarification, Aprill said. The schools would have revamped the programs more significantly if students hadn’t been protected from taxes.

“If such were the case, the programs undertaken by law schools to help former students engaged in public service employment would burden the recipients substantially, because of both income tax and payroll tax liability,” Aprill said in a February 2007 letter to Treasury Department and IRS officials.