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Student loan debt has become a major financial crisis, and its severity is increasing rapidly. One federal program designed to help is income-driven repayment, where your payments are determined by your income. This can provide some relief, but you should be ready to face taxes if any portion of your debt is forgiven.
The federal government offers three types of income-driven repayment plans:
Income-Based Repayment Plan (IBR Plan)
Pay As You Earn Repayment Plan (PAYE Plan)
Income-Contingent Repayment Plan (ICR Plan)
Each plan requires borrowers to contribute a portion of their discretionary income toward the loan over a 20- or 25-year period. Any remaining balance is forgiven if not paid off within the repayment term.
However, Business Insider reminds us that you are responsible for paying taxes on the forgiven amount. Depending on how large this amount is, your tax bill could be quite significant. If your loan accrues a lot of interest, a large portion of your loan could be forgiven, leaving you with thousands of dollars in taxes. To put this into perspective, in 2012, The New York Times reported on an estimate from the Office of Management and Budget:
The O.M.B. projected that from 2012 to 2021, 400,000 borrowers, each with an average starting loan balance of around $39,500, would ultimately receive loan forgiveness of approximately $41,000. Yes, you read that correctly. The forgiven debt could exceed the original loan amount, though it would take several years.
With $41,000 of loan forgiveness, the federal tax liability could easily exceed $10,000, depending on your tax bracket. Additionally, state income taxes may apply, depending on where you live.
Regardless of the amount, you will owe taxes on the forgiven debt in the year it is discharged. While it may not be a concern right now, it’s something to keep in mind for the future. It works similarly to a debt settlement. The government treats the forgiven amount as taxable income, and you will receive a 1099-C. You must report this during your tax preparation that year, and failing to pay could lead to penalties.
There are a few exceptions where student loan forgiveness is not taxable. For example, FinAid.org notes that teacher loan forgiveness programs, law school assistance programs, and the National Health Service Corps Loan Repayment Program are not subject to taxation.
The bottom line is: ensure you understand the specifics of the program you're enrolled in. For further details, check out the full article on this topic by Business Insider below.
Image courtesy of stevepb.
