Student Loan Forgiveness: Are there any tax implications?

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In the weeks leading up to the day that I received student loan forgiveness, I had discovered that anytime there is a loan forgiveness (or cancellation) you may have to pay taxes based on the amount that was forgiven. The amount forgiven would be considered income.

Throughout the rest of the year, I planned for and expected a tax hit, because of the loan forgiveness. Luckily, my forgiveness fell into a select category of occupations that are not required to report loan forgiveness as income. 

Related: We Crushed Our Student Loans Using Student Loan Forgiveness

Thus, my students loans were forgiven and there weren't any tax implications. For some of you interested in using student loan forgiveness, there may be tax implications. So, let's dive into the tax code and figure this out so you can plan for a tax bill (in certain professions).

Based on Publication 4681 of the tax code, a debt cancellation (or forgiveness) occurs when the lender cancels all or a portion of the debt. The cancelled debt must be reported as income, unless the cancelled debt is eligible for an exemption.

Tax- Exempt Types of Student Loan Forgiveness (Publication 970)

  • Must meet following requirements:
    • Work for a certain period of time, for certain professions and for a specific class of employers.
    • Must have attended an eligible institution.
    • Have loans from Qualified lenders: (US Gov, US State or Territory, 501(c)(3) Corp. that has assumed control of a hospital, or an eligible institution).
    • Services provided at a government unit or a qualified tax exempt section 501(c)(3) organization.
  • Work in an occupation with unmet needs, including:
    • medicine
    • nursing
    • teaching
    • law

Non- Tax Exempt Types of Student Loan Forgiveness

  • If the loans were forgiven, because of services provided to the institution that gave the loan (receive a loan from UT, work at UT and receive loan forgiveness from the work at UT).
  • Any occupations not listed above.

Basically, only people working in teaching, medicine, nursing, and law are eligible for tax free student loan forgiveness. Also, they are only eligible if they work a government owned organization or qualified 501(c)(3). 

Student loan forgiveness for any other occupation, must be reported on your taxes as income. The lender should report the forgiveness to the government using form 1099-C, but the IRS requires you to report the forgiveness on your taxes even if you don't receive a form 1099-C.

How much will I have to pay in Taxes?

The amount you pay in taxes is a simple calculation based on your income bracket. If your income falls under $100,000, then we look at the tax tables for 2016. Using the tax tables, I am going to list a few examples of the tax implications of student loan forgiveness. We will use my forgiveness amount of $22,500 in our examples.

Example 1:

  • $50,000 income
    • Taxes: Single - $8,278; Married filing Jointly - $6,576
  • $50,000 base income + $22,500 Student Loan Forgiveness = $72,500 total income
    • Taxes: Single - $13,903; Married filing Jointly - $9,951
    • Tax Increase: Single - $5,625; Married filing Jointly - $3,375

Example 2:

  • Extra Tax to Pay the Government by Tax Bracket
    • 25% of $22,500 = $5,625 in extra taxes
    • 28% of $22,500 = $6,300 in extra taxes
    • 33% of $22,500 = $7,425 in extra taxes
    • 35% of $22,500 = $7,875 in extra taxes
    • 39.6% of $22,500 = $8,910 in extra taxes

If you are in a profession that requires you to report student loan forgiveness as income, then you need to prepare for the tax hit. My wife and I did this accidentally, because we had $22,500 in the bank just in case the loan forgiveness did not go through.

You have 5 and sometimes 10 years to prepare for student loan forgiveness. So, you can easily prepare for the tax hit by saving. This is not an emergency. It is a known expense that occurs when receiving a loan forgiveness. Be prepared!

Other Things to know about Tax Free Student Loan Forgiveness

  • A refinanced loan qualifies for tax free Student Loan Forgiveness as long as the original loan was issued by a qualifying institution (listed above).
  • Student Loan Repayment Assistance is tax free when received from the following:
    • National Health Service Corps Loan Repayment Program
    • A state education loan repayment program eligible for funds under the Public Health Service Act.
    • Any other program that is intended to increase health care in underserved areas.
  • Can't deduct interest paid on taxes (only applies to interest that was paid by a loan forgiveness program).

Would any of you be interested in utilizing student loan forgiveness? Reasons why or why not? Does the possibility of a tax bill change your opinion of taking student loan forgiveness? 

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