When Are Student Loan Discharges Taxable?
The forgiveness fairy granted your wish and discharged your student loans. Are you done with your student loan debt? Not quite. You may have to pay taxes on the cancelled student loans, since the IRS considers some loan forgiveness to be taxable income to the borrower.
The government gives with one hand while taking back with the other. They replace your student loan debt with a tax debt.
It doesn’t seem fair, but it makes a weird kind of sense.
When any kind of debt, including student loans, is discharged or forgiven, it’s as though someone else gave you money to pay off all or part of your debt. The IRS treats this loan cancellation as though it were income to you.
So, unless Congress passed a law to exclude the specific type of loan forgiveness from income, you will have to pay taxes on it.
You will receive an IRS Form 1099-C (Cancellation of Debt) from the lender if the amount of cancelled debt is $600 or more. You must report the amount in Box 2 on the “Other Income” line of your federal income tax return.
Even if the amount discharged is less than $600, you are required to report it on your federal income tax return.
The good news is the tax debt from the loan forgiveness will be lower than the student loan debt. The tax debt should be equal to the product of the amount of cancelled debt and your tax bracket. For example, if you have $10,000 forgiven and are in the 22% tax bracket, you will owe the IRS $2,200 in addition to your regular tax bill.
The even better news? Some types of student loan discharges and student loan forgiveness are tax-free.
- If you work in a one of several occupations for a specified amount of time, the student loan forgiveness will be excluded from income. The specific occupations include teachers, nurses, doctors, dentists, veterinarians, public defenders, prosecutors and other public service jobs. The eligible loan forgiveness programs include Public Service Loan Forgiveness, Teacher Loan Forgiveness, National Health Service Corps Loan Repayment and state programs that are funded by the Public Health Service Act.
- The Federal Perkins Loan’s loan forgiveness programs are tax-free. This includes the cancellation of Federal Perkins Loans for teachers who serve low-income students, Head Start employees, special education teachers, members of the U.S. Armed Forces, Peace Corps volunteers, law enforcement and corrections officers, public defenders, STEM and foreign language teachers in shortage areas, nurses, medical technicians, fire fighters, faculty members at Tribal Colleges and Universities, school librarians and public librarians who serve low-income students and speech language pathologists.
- There is an exclusion from income for student loan death and disability discharges from 2018 through 2025, inclusive.
- Closed school discharges, false certification discharges and unpaid refund discharges are tax-free.
Unfortunately, some types of student loan cancellation and discharge are still taxable to the borrower. These include:
- The cancellation of the remaining debt after 20 or 25 years in income-driven repayment plans.
- Student loan repayment assistance programs (LRAPs) provided by employers and the federal government’s Office of Personnel Management.
The tax liability from the discharge of student loans may be waived by the IRS if the borrower is insolvent. You are considered to be insolvent if your total debt exceeds your total assets. To claim this exclusion from income, file IRS Form 982. For more information, read IRS Publication 4681.
If you aren’t insolvent, you can try negotiating an offer in compromise by filing IRS Form 656. This form must be filed by a tax professional, not the taxpayer.
If you don’t qualify for the insolvency exclusion or an offer in compromise, you can request a payment plan for up to six years using IRS Form 9465. Depending on your tax bracket, the monthly payment under the payment plan will be about a third of the previous student loan payment, but could be anywhere from 15% to 66% of the student loan payment.
If you are struggling with student loans, there are ways you could lower your monthly payment, including enrolling in an income-driven repayment plan, applying for a temporary deferment and refinancing student loans for a lower interest rate. However, refinancing federal loans into a private loan means a loss in benefits – income-driven repayment plans, any federal loan forgiveness programs, generous deferment options, and more.
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