Student Loans: You May Owe Taxes on Student Loan Forgiveness

If you get student loan forgiveness, it’s possible that you may owe income tax on the amount of student loans you get forgiven. Here’s what you should know about student loan forgiveness and taxes, and how you can manage your student loans accordingly.

Will I owe taxes on student loan forgiveness?

"Will I owe taxes on student loan forgiveness?" is a popular question about student loans. The answer depends whether you receive student loan forgiveness through an income-driven repayment plan. An income-driven repayment plan is a student loan repayment plan offered by the federal government that sets your monthly payment based on your discretionary income, family size and state of residence. There are four main income-driven repayment plans:

• Income-Based Repayment (IBR)
• Pay As You Earn (PAYE)
• Revised Pay As You Earn (REPAYE)
• Income-Contingent Repayment (ICR)

These income-driven repayment plans offer student loan forgiveness on your federal student loans after 20 years for undergraduate student loans and 25 years for graduate school student loans. When you get student loan forgiveness, you would owe income tax on the amount of student loans that ultimately are forgiven.

How not to pay taxes on student loan forgiveness

Many borrowers will not pay income tax when they get student loan forgiveness. Here are some examples:

• Public Service Loan Forgiveness. The Public Service Loan Forgiveness will cancel student loan debt, and you won’t owe any income tax.
• Teacher Loan Forgiveness. The Teacher Loan Forgiveness also won’t charge you any income tax on the amount of student loans that are forgiven.
• Total and Permanent Disability. If you have federal student loans and become totally and permanently disabled, your student debt can be cancelled and you won’t owe income tax.
• Student Loan Discharge.Through the borrower defense to repayment rule, your student loans can be discharged if your school closed or you were the victim of fraud.

Student loan forgiveness: What will I owe in taxes?

Here’s how student loan forgiveness can affect your income taxes. Under an income-driven repayment plan, you will pay on-time and in-full each month for 20 or 25 years. At the end of the repayment plan, you will have a final student loan balance that will be forgiven. The amount of that student loan balance is taxable to you, the borrower. The amount of tax you owe can be found by multiplying your income tax rate by your final student loan balance. So, if your final student loan balance is $10,000 and your income tax rate is 30%, you would owe $10,000 * 30%, or $3,000 in income tax.

Your personal tax situation may be unique, which can impact how much tax you owe. For example, you may have deductions, credits or other offsets that could impact the final amount of tax you pay when your student loans are forgiven.

How to manage student loan forgiveness

If you have an income-driven repayment plan, don’t think you won’t owe income taxes. Therefore, you must plan in advance. Here are a few action steps to take:

• Choose the right repayment plan. The income-driven repayment plan you choose can impact the amount of tax you may owe. Consider the amount of your monthly payment too. The lower your monthly payment, it’s possible that more interest accrues on your student loan balance. Therefore, you could save money upfront, but you may have a relatively larger final student loan balance. That could potentially mean more income tax liability. Review the income-driven repayment plans to choose the best plan for you.
• Save money. If you have student loans, it may sound counter-intuitive to save money. After all, you may be spending much of your income paying student loans. However, you likely may owe income tax on your student loan balance after 20 or 25 years. Therefore, save enough money to pay your tax bill so you’re not surprised.