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Federal student loans may be eligible for student loan forgiveness, but some borrowers may be surprised at the taxes on student loan forgiveness once they qualify for it.
In this guide, we’ll explain what loan forgiveness tax is, when forgiveness results in a tax bill and when it doesn’t, and how to prepare for loan forgiveness tax consequences as a borrower.
In this guide:
When is student loan forgiveness taxed?
Taxability on student loan forgiveness depends on the reason for forgiveness.
Generally, the amount isn’t taxable if your loans are forgiven through a program like the Public Service Loan Forgiveness program (PSLF), which requires you to work in certain public service professions such as teaching, law, or health services.
It also won’t be taxed for forgiveness due to death or permanent disability of the borrower.
But there are other instances where the IRS will treat your forgiven debt as income and tax you accordingly. Here are the current student loan forgiveness programs available to federal borrowers and how each affects your taxes.
|Loan forgiveness program||Forgiveness criteria||Repayment term||Taxable event|
|Public Service Loan Forgiveness (PSLF)||Work for federal, state, or local government; or a 501(c)(3) organization||10 years, 120 payments||No|
|Income-driven repayment plans||Enrolled in an income-driven repayment plan||20 or 25 years||Yes|
|Law school repayment assistance||Work at an eligible employer or have attended a school with a forgiveness program||Varies based on forgiveness program||No|
|Cancellation due to school closure||Enrolled in school at the time the school closed, or left within 120 days of the school closing||N/A||Yes|
|Cancellation due to false certification or unauthorized payment||Student’s school falsely certified their eligibility for federal aid||N/A||Yes|
|Death or disability discharge||Borrower passed away or is permanently disabled||N/A||No|
|Teacher Loan Forgiveness Program||Work for a qualifying school for at least five consecutive years||Five years||No|
|Loan forgiveness for nurses||Work in a high-need, low-income area as a nurse||Two to three years||No|
There are some exceptions to the tax requirements on student loan forgiveness.
First, should a borrower be considered insolvent even after loan forgiveness, all or a portion of forgiven student loan debt may be free from federal income tax. The IRS considers you insolvent if your total liabilities are more than your total assets.
Be aware of differences between federal income tax and state income tax. While the federal government may absolve you of tax liabilities for student loan forgiveness, that may not be true for state taxes. Your loan servicer should be able to provide clarity on state tax consequences.
How do taxes on student loan forgiveness work?
When your loans are forgiven, your loan servicer will send you a copy of the IRS tax form 1099-C. Don’t ignore this. The 1099-C details the amount forgiven, and you must report it on your taxes for the applicable tax year.
The tax consequences of your student loan forgiveness will vary based on your total income for the year. Your forgiven debt is included in your taxable income, so it could move you into a higher tax bracket just like earning more income would.
For example, let’s say you earn $39,000 in taxable income and are filing as a single person:
- Your top tax bracket for 2019 is 12%. Your first $9,700 is taxed at 10% and the rest at 12%.
- Your total taxes owed will be $4,486, most of which you would have likely already withheld from paychecks throughout the year.
Now, if you had $50,000 in student loan debt forgiven in the year you earned $39,000, that $50,000 is added to your total income for the year. This means the IRS views your income at $89,000, and taxes you on that total:
- Your top tax bracket is 24%. Your first $9,700 will be taxed at 10%, up to $39,475 at 12%, up to $84,200 at 22%, and the rest at 24%.
- Your tax bill would be $15,535, which you may not have planned for when determining your withholding.
These figures leave out certain exceptions, such as the standard deduction, but they illustrate how you could end up with a big bill instead of your usual tax return.
Compare those figures, and you can see why it is crucial to understand whether your loan forgiveness is a taxable event and plan accordingly.
>> Read more: Student Loans & Taxes: What Deductions Can You Take?
Don’t default on your taxes
The last thing you should do is avoid dealing with reporting everything when you file your taxes. You need to report the 1099-C amount on your tax return and determine how to take care of what you owe in a timely fashion.
Although you may think it unfair to be taxed when student loan debt is forgiven, consider the alternative: thousands of dollars of loan payments to pay down for a decade or more. Ongoing student loan repayment can make it difficult to work toward other financial goals.
This debt relief, even with the tax consequences, can be a lifesaver for many student loan borrowers.
The IRS takes tax bill default quite seriously. You could face a delinquency mark on your credit report and wage garnishment. These consequences can drastically reduce the benefits of receiving student loan debt forgiveness in the first place.
What to do if you can’t afford the tax bill
While student loan forgiveness is a wonderful opportunity, that doesn’t make the debt forgiveness tax any easier to swallow. Thousands of dollars of extra taxes in a single year may be challenging to pay.
To avoid defaulting on your taxes, get in touch with the IRS immediately if you cannot pay your tax bill. The IRS will appreciate your cooperation, and it offers payment plans that will let you pay your bill in installments over time.
Author: Melissa Horton