Student Loan Forgiveness Can Create a Big Tax Debt. Student loan debt levels are out of control.
Need proof?
The class of 2017 graduated with an average of $39,400 in debt.
Some graduates have balances much higher than that – up to $100,000 or more – ballooning even higher as interest continues to rack up after they graduate.
Many students didn’t know what they were getting themselves into.
And if parents co-sign for these loans, they can also be subject to wage garnishments and other nasty consequences. (BankRate’s “3 Terrifying Student Loan Horror Stories” and Yahoo Finance 9 Unbelievable Student Loan Horror Stories tell the terrifying tale).
That’s why student loan forgiveness can be such a saving grace for folks saddled with seemingly-endless monthly payments on large balances – all while trying to get a job, eat, put gas in the car, and maybe have a life on the side. The problem is that it can create a huge tax burden, and many times participants are unaware of this when they pursue a student loan forgiveness program.
What is Student Loan Forgiveness?
If you have a federal student loan, there are student loan forgiveness programs out there which wipe out your balance due. (If your student loans came from a private lender or bank, that’s a different story, unfortunately).
Some programs are only available to those who pursue particular occupations, such as nurses, teachers, and public service employees. However, the income-driven repayment forgiveness is not restricted by the type of work you are doing, making it an option for many more borrowers.
With this plan, your payments can be capped at a percentage of your income each month. After 20 to 25 years of payments, your balance is eligible for forgiveness.
Obviously, if you have a balance you can pay off before then – in monthly payments that you can handle – you might as well skip the plan and continue with your payments.
However, if your student loan debt is large enough (and your payments wouldn’t leave you enough to live on), then income-driven repayment forgiveness might just be the way to go.
Sounds good? It can be.
There’s just one thing you’ll need to be aware of… taxes, of course.
Dark Lining on a Silver Cloud: Paying Taxes on Student Loan Forgiveness
The amount of your student debt loan that gets forgiven counts as taxable income. That means you will have to add the amount to your income and pay taxes on it. Depending on how large the amount forgiven was, your tax bill can be pretty substantial.
There are exceptions, of course.
Those who can take advantage of the teacher and public service employee programs generally do not have to pay taxes on debt forgiveness.
Also, if you become permanently disabled, you won’t pay taxes on any amount forgiven, either. This is not an appealing outcome, however.
You may also avoid paying taxes on the amount of debt wiped out with a student loan forgiveness program if you are able to prove insolvency.
Here, an Enrolled Agent can be helpful in reviewing your options (and the tax consequences of each).
What if I Have to Pay Taxes on my Forgiven Student Loan?
You will receive a 1099-C for this amount in the mail. You must claim it on your tax return for that year. The amount will be taxed as income and due at the deadline. If a large amount of tax is due, you may be also be assessed an underpayment penalty by the IRS as well.
What if I Can’t Pay the Taxes on my Student Loan?
If you cannot pay the amount, you do have options.
You can request an Installment Agreement with the IRS to pay your taxes over time. You will still pay penalties and interest as well as a set-up fee.
If it’s not possible to repay your debt in a reasonable amount of time, an EA can explore other avenues toward conquering your tax debt, including an offer in compromise.
Get the Professional Advice You Need
It’s great that there is a way out for many who are sinking due to student loan debt. Do yourself a favor, though, and speak with an Enrolled Agent before you pursue a student loan forgiveness program. He or she can run the numbers for you on different scenarios, as well as advise you on the tax consequences of each.
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Jeffrey Schneider, EA, CTRS, NTPI Fellow has the knowledge and expertise to help you reach a favorable outcome with the IRS. He is the head honcho at SFS Tax & Accounting Services as well as an Enrolled Agent and a Certified Tax Resolution Specialist.
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Now What? I Got A Tax Notice From The IRS. Help! Defining and deconstructing the scary and confusing letters that land in your mailbox. Jeff defines and deconstructs the scary and confusing letters in a fashion that mixes attention to detail with humor and an intricate clarification of what is what in the world of the IRS.
The book is available in paperback and ebook on https://Amazon.com
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For more on SFS Tax Problem Solutions, visit: http://sfstaxproblemsolutions.com/
For more on SFS Tax & Accounting Services, visit https://sfstaxacct.com/
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