If you’re struggling with education debt, student loan forgiveness and discharge programs may sound like a dream come true.
But depending on which forgiveness or discharge program you qualify for, you could get hit with a hefty tax bill after your balance is wiped out. Below, find out how seven different forgiveness and discharge programs work and which treat your forgiven balance as taxable income.
1. Public Service Loan Forgiveness (PSLF): not taxable
With PSLF, your remaining loan balance will be forgiven after you make ten years of payments while working for a qualifying non-profit or government agency. Since most people who apply for PSLF are lower-income, the savings can be significant.
Best of all, the forgiven balance is not taxable under PSLF. That means you won’t owe extra money at tax time.
2. Income-driven repayment (IDR) plan forgiveness: taxable
Signing up for an IDR plan is a great way to reduce your monthly payment, giving you more breathing room in your budget. And, if you make 20 to 25 years of payments — depending on which plan you qualify for — the remaining balance will be forgiven.
However, IDR plan forgiveness works differently than PSLF. The forgiven balance under an IDR plan is taxable as income, potentially leading to a high tax bill.
For example, let’s say you had $50,000 in student loans and had a $30,000 salary. If you signed up for Pay As You Earn (PAYE), one of the four IDR plans, you’d make payments for 20 years. At the end of that time, the government would forgive $46,658. That money would be added to your yearly income during the tax year it was forgiven. That means you'd be on the hook for paying additional income tax, over and above what your employer withheld from your compensation.
3. Teacher Loan Forgiveness: not taxable
If you teach full-time for five consecutive years in a low-income school or eligible service agency, you could qualify for up to $17,500 in loan forgiveness.
Thankfully, the money you receive under this program is not taxable as income.
4. Closed school discharge: taxable
You could qualify for student loan discharge — which could eliminate 100% of your federal loans — if you meet one of the following criteria:
Your school closed while you were still enrolled
You were on an approved leave of absence and your school closed
Your school closed within 120 days of your graduation
Per the tax code, loans forgiven under closed school discharge are taxable as income.
5. False certification discharge: taxable
False certification discharge applies when a school falsely claims you’re eligible to receive a federal student loan. For example, if you don’t have a high school diploma or GED, you don’t qualify for a loan. If your selected school lies and says you had a diploma, allowing you to take out federal loans, you could qualify for false certification discharge.
Unfortunately, even if it’s the school’s fault, the forgiven balance is taxable as income.
6. Total & permanent disability discharge: not taxable
Previously, the loans forgiven under total & permanent disability discharge were taxable as income. However, a new rule went into effect in January 2018 which made forgiveness under total & permanent disability discharge not taxable any longer.
7. State-sponsored repayment assistance programs: program dependent
Many states operate repayment assistance or forgiveness programs for certain professions, such as healthcare professionals and lawyers. Whether or not you’ll have to pay taxes on the assistance you receive is dependent on the specific program. Contact the program’s administrator to find out if it’s taxable or not.
Is loan forgiveness worth it?
Although the idea of facing a large tax bill can be scary, that doesn’t mean you shouldn’t apply for loan forgiveness or discharge if you qualify for it. The amount forgiven is much higher than your tax bill, so it’s a worthwhile tradeoff to have that debt eliminated. You simply need to be aware of the tax implications so you can prepare for tax season.
Not eligible for student loan forgiveness? Consider refinancing your student loans. It takes just a few minutes and could help you save thousands.