If you’ve been dealing with student loans for some time, you know that the number of forgiveness programs is quite numerous. However, you’ll find that the eligibility requirements can be quite tricky if you would like to consider them. It doesn’t get any better when you need to fulfill tax obligations on your forgiven student loans. Hence, we’ll look at student loan forgiveness and taxable income, so as to understand how and where these two intersect.
As a consumer, the moment your debts get canceled, there are times that the IRS receives a report because they consider this an income that you earned. As a result, the IRS may expect you to pay money taxes on this income. Just as you would for money earned through a business transaction. Hence, the student loan forgiveness and taxable income problem. Usually, you will receive a 1099-C form from your lender when it’s the tax season for the year before to cover canceled debts.
For instance, let’s say a student borrows a total of $20,000 loan and this gets cancellation in February 2020. For this, she will receive 1099-C in the first quarter of 2021. The moment the form is received, it should tell that the student has student loan taxable income. Usually, you’ll have to spend a considerable amount of money on these taxes.
It might seem hard to consider your student loan forgiveness taxable income. However, you need to be ready to deal with the reality even though not all forgiven student loans are taxable. Hence, let’s take a closer look at it.
For many, there are no other options to finance tertiary education than to get student loans. Whether this money can be considered an income or not depends largely on rules set by the IRS. Typically, the IRS is bent on everyone playing it fair with their taxes. They take particular interest in taxes on wages, salaries, dividends, commissions, tips, and interests. Other forms of residual income such as side hustles and hobbies.
If this list seems extensive, it shouldn’t worry you because it also comes with a silver lining. That’s because the taxes you need to pay to depend on the deduction you make of your credits and tax exemptions from your gross or overall income.
In this case, you need to know that those financing their education with different types of packages might have to pay taxes. Because the IRS also considers some of these programs as income even if they get forgiven. Hence, this page is dedicated to helping students understand how student loan forgiveness and taxable income relate.
Therefore, if you have received or plan to take funding from external sources to finance your education, you will have to pay attention to the following:
If you’re lucky, your employer might have some programs in place to help cover the cost of professional advancement and education. Also, there are loan repayment packages that might be in place to help attract the best candidates. Hence, if you find yourself working with any such employer, you can cover the cost of loan repayment or education for career advancement purposes.
Through such programs, your employer gets to help you repay your money to pay for education costs such as course materials, and tuition fees. Usually, your education needs to contribute directly to your job. Your employer can then make payments to your lender to cover the funds that you borrowed to finish your education.
the only disadvantage, all the money you receive from your employer in the student loan assistance program is taxable income. Usually, these taxes will come up if your plan provides more than $5,250 and upwards. Mind you, the employer, in this case, is responsible for reporting taxable part of your income in the federal W-2 form of their employees.
Educational institutions belonging to the NCAA Division one and two offer about 2.9 billion U.S. Dollars among over 150,000 student-athletes through their athletic scholarships. Usually, these types of financial aid don’t attract any taxes provided they fall within certain criteria determined by the IRS.
Nevertheless, you need to remain aware than only the part of the scholarship used for educational materials and tuition do not attract taxes. On the other hand, you’ll have to pay taxes on part of the money you use to cover the cost of incidentals and accommodation.
Maybe you are an undergraduate or graduate student that’s currently working. The student loan forgiveness and taxable income you’ll have to deal with depends on whether you receive hourly pay or salary. In essence, if you find yourself in the work-study program, your income then becomes taxable. Therefore, the IRS will have to receive its filing and the corresponding payments in taxes.
Typically, you’ll receive a federal W-2 form from your school that contains all the necessary details essential for filing this taxable income.
At this point, it’s pretty clear the IRS doesn’t forget, neither does it forgiven discharged or some forgiven student loans. Therefore, there are serious tax implications associated with student loan forgiveness.
If your private or federal student loan gets canceled, the balance you’re left, that you don’t have to pay your lender, remains the taxable portions of the original loan you took. Hence, it’s important you work out the amount you’ll pay in taxes prior to settling your debt as a student borrower.
For instance, you pay $20,000 as taxes on a forgiven student loan of $80,000, it’s quite agreeable that paying this reduced amount in taxes is better than paying the full amount of the debt. However, the large majority of student borrowers might not be capable of paying $20,000 as taxes.
If you find yourself in such a situation, you need to contact a tax advisor as soon as possible. You’ll never know that you meet the requirements for insolvency until you talk to an expert. Once your case is insolvent, you don’t have to include your forgiven loans in your gross income.
Usually, the same case applies for federal student loan forgiveness programs, the government may forgive your outstanding balance after you’ve made a specific number of repayments on time. However, the IRS will be waiting for their taxes on the total amount you were forgiven.
You may not always be sure if you fall within this category. Therefore, it’s important to watch out for a 1099-C form in your mail. Once you get this, you can be sure that your student loan forgiveness taxable income needs closer attention for the sake of the IRS.
Generally, not all forgiven student loans are taxable. Some are while others do not attract any taxes.
According to general legislation, the amount you were forgiven usually stands for the amount of student loan taxable income for the year it was written off. However, this isn’t the case in every instance. There are certain exceptions to this rule and you need to know about them.
Typically, you’ll not have to pay any income taxable for forgiven student loans provided you are employed in certain professions for a specific number of years. As such, programs like the National Health Service Corps Loan Repayment Program, teacher loan forgiveness, Public Service Loan Forgiveness, and law school loan repayment assistance program attract no taxes.
On the other hand, discharged loans from false certification, disability, death, closed schools, and unpaid funds are all taxable income. Also, the topic of student loan forgiveness and taxable income covers the remaining amount in repayment programs considered income-contingent after remaining in the same program for 25 years.
According to the Internal Revenue Code of 1986, to be more specific, Section 61 (a)(12), your gross income is made up of discharged debts that are equal or above $600 for any particular year. Yet still, Section 108(f) of the IRC stipulates the conditions under which student loan forgiveness remains nontaxable.
From this section, we deduce the programs that fall under the gross income and those that the government and IRS do not consider part of the gross income. Primarily, discharges are not included in the gross income. However, it’s important to know the specific criteria that surround these discharges and the other programs that are exempted from your taxable income.
Usually, when there is a partial or impartial discharge of a student loan, it involves a beneficiary that is an employee at an eligible employer for the set amount of time. Hence, you also want to pay attention to your career choice at an earlier stage.
From this same section, a “student loan” is any loan offered to students to assist them to complete education at an institution. The United States or US agency must have been the maker of this loan. This agency can either be a state government, charitable organization, educational institutions or private entities.
Usually, the origin of the loan determines its taxability. Hence, you will find that your loans become taxable if they come from any of the three primary sources of funds listed above. As a student, you will be eligible to tax exemption if you don’t happen to be employed by the educational institution that’s discharging your student loans. Also, you are eligible for tax exemption if your refinanced student loans get forgiveness under specific conditions.
Students owing loans that they are paying back with an income-driven repayment plan stand a higher chance of dealing with student loan forgiveness and taxable income. Generally, these plans take about 20 to 25 years to complete. By the end of this period, if your loans aren’t fully paid, the outstanding amount is written off. However, this amount becomes your taxable income.
Below, you’ll find some of the programs under which you’re excepted from payable taxes.
If your student loan gets written off through the Teacher Loan Forgiveness and Public Service Loan Forgiveness, even programs such as National Health Service Corps Loan Repayment and other repayment arrangements do not attract any taxes.
You become eligible when dealing with parent PLUS loans. In case a complete permanent disability or death occurs, your estate will not have to pay taxes on the discharged amounts.
In case your school get closed down or defrauds its students, your forgiven student loan debt is tax-free.
If you meet the requirements for Perkins Loan Cancellation by teaching or working for an employer, it is not considered taxable income.
There are many active student loan forgiveness programs in different states. For instance, the Maine Dental Education Loan provides students about $20,000 each year for loan forgiveness. If you are a beneficiary of this program, you are exempt from paying taxes on these amounts. Nevertheless, you’ll have to verify from operators of the program just to be sure about the liabilities associated with the program.
Actual Amounts Payable
The total amount of taxes you need to pay on your forgiveness student loans depends on two factors, your finances and the actual amount forgiven. In some instances, students move into a higher tax bracket due to forgiven loans. Therefore, you have gotten your student loans forgiven but you’ll have more burdens in taxes.
For instance, you get married, and jointly file your taxes with two additional dependents. Assuming $100,000 is your taxable income and you go for the usual deduction, you will find yourself owing the IRS $4,684 since you’ll be in the 12% tax bracket.
However, if the amount of your forgiven student loans is $50,000, you will move up the tax bracket. To be more precise you’ll find yourself in the 22% tax bracket. In this case, you’ll have to give Uncle Sam $15,349, making a difference of $10,665.
You end up not getting anything from the additional income. In some states, you won’t have to pay such income taxes. A good example being Minnesota, where benefits received from income-driven repayment plans are not considered taxable incomes. As always, we recommend you talk to an expert.
Generally, you can avoid paying taxes on your student loan forgiveness benefits if you can obtain funds from the following options to cover the cost of your education in higher institutions.
Repayable federal and private loans for students are not taxable incomes because you’ll have to make repayment at some point. However, there are some important facts you need to know about. Firstly, you must have been seeking a degree at an eligible school and strictly use your funds to cover fees and tuition if these benefits will be non-taxable income.
The moment you use your scholarship to cover other costs apart from fees and tuition, such as travel and personal expenses, the IRS will expect taxes on these additional expenses. To help you better understand, let’s look at a quick example.
Assuming you receive $16,000 as scholarship funds, and use $10,000 to pay for fees and tuition, the remaining $6000 becomes your taxable income.
If you find yourself in the position of a dorm resident advisor, your little drama and long hours might come to some good advantages. Usually, you’ll get a freeboard and rooms. Such benefits are exempt from income taxes.
It’s easy to understand why, because your university needs you to live in the provided accommodation as part of your employment conditions. This makes it part of your employer benefits.
Some arrangements made to cover the future education of children can become tax-free under specific conditions. Typically, the Coverdell education savings accounts, 529 college savings accounts, and Series EE bonds fall within this category when you finance your education with funds from these accounts.
Also, those with a 529 plan can take out about $10,000 from their account with the need to pay any taxes and use this amount to either pay for the cost of an apprenticeship program or repay qualified student loans.
Remember to read in-between the lines because the terms and conditions of each of these accounts vary when you try to withdraw tax-free money.
Generally, discharged debt above a certain amount is taxable. This is the usual case of student loan forgiveness and taxable income. However, due to the introduction of new policies for taxes, certain private and federal student loan discharges that occur between 1st January 2018 and 31st December, 2025 are not taxable because of disability or death of student borrowers.
There are requirements such as attending eligible educational institutions and borrowing from eligible sources. Also, if you believe your school misled, deceived or conducted itself in an illegal manner regarding your loans, you may be exempted from paying taxes on such loans. In some situations, this exemption applies to private student loans too.
In addition, if you failed to complete your degree program due to the closure of your school, you will not have to pay taxes on your forgiven loans.
Public Service Loan Forgiveness (PSLF)
You’ll get your federal student loans forgiven under the PSLF provided you make a number of at least 120 validating payments. These payments are also called qualifying payments because you make them under 10 years or more standard plans. At the time, you must be a full-time employee of an eligible employer in the public service. Once you meet these requirements, your loans can get forgiven without any additional taxes.
According to the U.S. Department of Education, the PSLF is exempted from student loan forgiveness and taxable income challenges. Therefore when you get your federal student loans forgiven under this program, the burden leaves you for good.
Perkins Loan Forgiveness
These are loans with the backing of the federal government but offered by your education institution. Typically, their low interests, low balances and considerate terms of payment. Also, you can meet the eligibility requirements for a number of job-dependent loan forgiveness programs. This is especially the case for certain workers in the health sector and teachers too.
The Perkins student loan forgiveness and taxable income benefits share similarities with the advantages of PSLF by not being taxable.
Usually, borrowers get the opportunity to settle defaulted student loans for less than they owe. In the case of federal student loans, there are stringent guidelines that govern the settlement of federal student loans. However, private student loans can be less strict. Therefore, you can easily overcome a huge debt by negotiating a balance reduction. This type of open-mindedness of some private loans makes them very attractive to government workers.
However, it’s important to state that your portion of the loan you settle through negotiation or any other means will be taxed by the IRS. Hence, you can look forward to receiving a 1099-C when you benefit from this program.
Next, let’s look at insolvency.
This is the solution provided in cases where student loan forgiveness and taxable income intersect leading to the issuance of the 1099-C. In this case, you can get a reduction in the amount of taxes you need to pay if you can prove that the funds were insolvent.
Insolvent in the sense that the total amounts of debts you had to pay exceeded your total assets at the time of the cancellation of the debts. If you’re a borrower, you fill out a sheet for insolvency along with your tax return to let the IRS know that your debts are insolvent.
Considering student loan forgiveness and taxable income to understand where the two intersect isn’t an easy task. Therefore, we recommend student borrowers talk to the appropriate authorities on the topic before taking any major decisions. Some of these could be tax specialists or accountants who can do various things for you such as leverage analysis. These professionals will significantly help you make the right determination of taxability.