Student loans have become a significant factor for many Millennials’ financial present and future. Over the past few years, 70 percent of college graduates have had at least some debt upon graduating from college. The average amount for 2016 graduates is $37,172, and that is before interest starts to accrue. More than half of Millennials with student loans have no idea when they will be able to finally be free of their student loan debt. Many students dream of the day that their student loan is forgiven and they can walk away debt free. However, the reality is that there is a downside to student loan forgiveness: taxes.
Taxable Income and Debt Forgiveness
It is current IRS procedure that any debt that is canceled or forgiven counts as taxable income and must be reported on your tax return. This includes student loan forgiveness programs, including income-sensitive repayment options that forgive the rest of loan after a term of 10-25 years. The programs covered under this include Pay As You Earn (PAYE), Income Contingent Repayment (ICR), Revised Pay As You Earn (REPAYE), and Income-Based Repayment (IBR).
This means that when you come to the end of your term, you no longer have to worry about your student loans anymore. However, you might just be hit with a whopping tax liability that you will be expected to pay all at once come Tax Day. Depending on how much you still owe, your filing status, and your tax bracket, you could end up with a tax bill of 10,000 or much, much more. Many people in these programs do not realize that this is coming to them, and instead just anticipate with happiness the day that they no longer live with their student loans.
Exceptions to the Rule
There are a few exceptions to this rule, which are mainly programs that provide forgiveness in exchange for working in public service jobs or as a teacher. The IRS has a few criteria that you must follow in order to be exempt from having to claim this student loan forgiveness as income.
First, you must have borrowed the loan from a qualified lender. This includes the federal student loans that come from the United States or a state institution. Any tax-exempt public benefit corporation also qualifies as a lender. It might also apply if you borrowed from an eligible educational institution, as long as the loan was made as part of an agreement with the United States, a state, or a public benefit corporation. The exception also applies for loans that were in place to encourage more employees in underserved positions or areas, such as medicine, nursing, law, and teaching. Refinanced loans might also be considered exempt as long as it was done through a qualified lender or through an organization encouraging more work in underserved work or communities.
There are also repayment assistance programs that also will be tax-free, as long as they come from the National Health Service Corps Loan Repayment Program, a state educational loan repayment program that is eligible to receive funds under the Public Health Service Act, or any other loan repayment or forgiveness plan that helps to increase the number of healthcare workers in underserved communities. There is also an exception to this exception: if you ever had the loan canceled due to performing services for the organization or education institution that provided the loan.
The Changing Tide
What about for everyone else? There is legislation currently introduced to help out everyone who will have their student loans forgiven as part of the income-based repayment schemes. In 2015, a bill known as the Student Loan Tax Debt Relief Act was introduced by 35 House members including Jim McDermott (democrat from Washington). Representatives Frederica Wilson (Democrat from Florida) and Mark Pocan (Democrat from Wisconsin) introduced a bill known as the Relief for Underwater Student Borrowers Act in 2014. This would exempt student loan borrowers from having to pay taxes on their canceled loans, as long as they were consistently repaying their loans throughout the life of the loan. Neither bill has been passed, but hopefully, something will be in place before the terms are up on the millions of borrowers currently enrolled in one of the income-based repayment scenarios. It is unfair for them to finally get rid of one debt only to be facing another one in the form of a large tax bill.
If you already are facing a significant tax debt, there are ways to find some relief. Call Fidelity Tax Relief today at 877-372-2520 and speak with one of our tax professionals to learn more about your options, including an Offer in Compromise and Installment Agreement.