Do I have to pay taxes on forgiven student loans?

The Credible Money Coach shares some good news about student loan forgiveness and federal income taxes. (Credible)

Dear Credible Money Coach,

I just read [a Fox Business] article on student loan forgiveness. There was nothing said about the amount of the forgiveness being taxable. I understand that it is counted as income. Am I correct? Or am I lucky and that amount is not taxable? — Kay

Hello Kay, and thank you for a great — and timely — question. The idea of not having to repay a debt can be appealing, so it’s easy to forget that the IRS generally classifies canceled, forgiven, or discharged debt as taxable income. You generally must report forgiven debt as income on your federal tax return for the year when the debt was forgiven.

But there are some exceptions, including certain types of student loan debt forgiveness.

If student loan forgiveness isn't an option, refinancing private student loans may allow you to get a lower interest rate or more manageable monthly payments. Credible makes it easy to compare student loan refinancing rates from multiple lenders.

Good news from the American Rescue Plan Act

In response to the ongoing financial crisis caused by the COVID-19 pandemic, the federal government enacted the American Rescue Plan Act in March 2021.

Among its many provisions aimed at bolstering the economy, the act temporarily made forgiven student loans excludable from gross income for tax purposes. That means if you have a federal or private student loan forgiven for any reason between Dec. 31, 2020, and Jan. 1, 2026, you won’t have to pay federal income tax on the forgiven amount.

Keep in mind that if your state has its own income tax, it may handle forgiven student loan debt differently. The act’s provisions only apply to the federal Internal Revenue Code. That said, many states choose to follow federal tax rules for their own tax codes. If you’re unsure of your state tax liability, consult a qualified tax professional.

It’s also worth noting that not everyone can qualify for student loan forgiveness.

Types of student loan forgiveness

The U.S. Department of Education, which makes federal student loans, allows forgiveness of federal student loans under these programs:

• Closed school discharge — If you’re enrolled in a school when it closes, or it closes soon after you leave the school, you may be eligible to have your Direct Loan, Federal Family Education Loan (FFEL), or Perkins Loan forgiven.
• Teacher Loan Forgiveness Program — This program, available for Direct and FFEL Loans, allows educators who’ve taught full-time for five consecutive academic years to have up to $17,500 forgiven provided they spent those years working in a low-income elementary or secondary school, or an educational service agency.
• Perkins Loan cancellation or discharge — Teachers with Perkins Loans may be able to get all or some of their loans forgiven if they work in a school that serves low-income families, as a special education teacher, or teach math, science, foreign language, bilingual education, or in another field with a shortage of qualified teachers as determined by their state. The amount they can have forgiven depends on their years of service.
• Disability or death discharge — If a borrower becomes totally and permanently disabled, or they pass away before finishing their loan repayments, their Direct, FFEL, and Perkins Loans may be forgiven.
• Borrower defense to repayment — If your school misled you, engaged in misconduct, or violated certain state laws, and you took out your loans specifically for the purpose of attending the school, you may be able to qualify for this type of federal loan discharge.
• Public Service Loan Forgiveness — People who work full-time for a specified length of time in certain jobs of public service — generally, for the government at any level or for a qualifying not-for-profit organization — may qualify for forgiveness under this program. You’ll have to meet all qualifications, including making a certain amount of payments on an eligible federal student loan.

How student loan forgiveness normally affects taxes 

Student loans forgiven outside the temporary time frame provided for in the American Rescue Plan are generally considered taxable income, except federal loans forgiven under the Public Service Loan Forgiveness Program, the Teacher Loan Forgiveness Program, and Perkins Loan cancellation. If your loan was discharged because your school closed or engaged in wrong-doing, the forgiven amount may also be non-taxable.

Forgiveness at the end of an income-driven repayment (IDR) plan, or discharge due to death or disability, is usually subject to federal income tax.

Options if you don’t qualify for student loan forgiveness

Forgiveness isn’t the only way to make a student loan more manageable, or to get rid of it faster. Depending on your financial situation and the types of student loans you have, an IDR plan, federal Direct Consolidation Loan, or refinancing with a private student loan may be options. 

Just be aware that while refinancing federal student loans into a private one may allow you to lower your interest rate, reduce your monthly payment, and extend the time you have to repay the loan, you’ll also lose federal student loan benefits. If you're considering refinancing a student loan, it's a good idea to compare rates. Credible makes it easy to see rates from multiple lenders.

Ready to learn more? Check out these articles …

• A guide to student loan forgiveness programs
• How to pay off $100K in student loans
• 3 relatively cheap ways to pay off tax debt
• Tax preparation checklist: What to know before filing
• 5 reasons to file your taxes early

Need Credible® advice for a money-related question? Email our Credible Money Coaches at [email protected]. A Money Coach could answer your question in an upcoming column.

This article is intended for general informational and entertainment purposes. Use of this website does not create a professional-client relationship.  Any information found on or derived from this website should not be a substitute for and cannot be relied upon as legal, tax, real estate, financial, risk management, or other professional advice. If you require any such advice, please consult with a licensed or knowledgeable professional before taking any action. 

______

About the author: Dan Roccato is a clinical professor of finance at University of San Diego School of Business, Credible Money Coach personal finance expert, a published author, and entrepreneur. He held leadership roles with Merrill Lynch and Morgan Stanley. He’s a noted expert in personal finance, global securities services and corporate stock options. You can find him on LinkedIn.

Source: Read Full Article