Can Debt Forgiveness Cause a Student Loan Tax Bomb?

Student loan cancellation is a hotly debated issue for Americans who took on debt to attend college. While you can get a loan forgiveness with less money to pay off later, your finances can still take a short-term blow from an unlikely source: a student loan tax bomb. This is especially the case for borrowers on income-tested repayment plans that are not part of the federal qualifying student loan exemption programs.

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Fortunately, lawmakers may have a way to protect borrowers unable to pay that tax bill. Learn more about a possible student loan tax bomb, loan cancellation, and how to fight this tax coup.

What is a “tax bomb” student loan?

A “student loan tax bomb” occurs when your student loan lender waives all or part of your debt, forcing you to include that amount in your taxable income.

Typically, the IRS taxes all sources of income. When a creditor cancels, forgives or discharges a debt, they erase some or all of the amount of your outstanding balance. The remitted amount is usually included in your gross income and subject to income tax. You will declare this balance on Form 1099-C, Debt Cancellation.

How can student loans be canceled?

Canceling the loan means that you no longer need to pay off all or part of your loan balance. You may be eligible for a loan forgiveness if you meet specific eligibility criteria and follow all the rules set out in government loan programs like the public service loan forgiveness or teacher loan forgiveness programs. . Check payday loan here: https://oakparkfinancial.com/payday-loans-no-credit-check/

In most federal student loan programs, if you follow the rules and make all of your payments, the canceled balance will likely be tax free.

You can also get your student loans canceled if you pay them off under an income-based repayment plan. This requires you to make monthly payments in proportion to your discretionary income, typically over 20 or 25 years. Any balance remaining after this period will be forfeited and likely considered taxable income.

The COVID-19 pandemic has also resulted in federal student loan relief as the government decided to defer payments borrowers need to make without accruing interest. The Ministry of Education initially suspended loan payments, quickly followed by an extension until September 30, 2020, with the passage of the CARES Act, and finally an additional executive decree extending the suspension until September 30, 2020. December 31, 2020.

Another executive order extended the deferral of federal student loan payments until September 30, 2021.

Situations that can cause a tax bomb

The forgiveness of a federal student loan balance and the resulting tax bomb primarily impact borrowers who use income-based repayment plans. These payment plans last for a fixed term, usually 20 or 25 years, and require you to pay between 10% and 20% of your discretionary income until you pay off the loan.

Any balance remaining after the end of the payment plan is canceled. This forgiven amount may be considered taxable income in the year it occurs, depending on your repayment plan and loan program.

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Situations that will not cause a tax bomb

If you receive a loan forgiveness under federal student loan programs, it will likely count as a tax-exempt gain (or reduction in liability). Typically, you won’t be faced with a tax bombshell resulting from loan forgiveness in the following situations:

You successfully participate in an eligible federal loan program. If you follow the rules for programs such as Public Service Loan Forgiveness, Teacher Loan Forgiveness, and similar federal loan programs, any loan forgiveness you receive should not be taxable.
You die or become permanently disabled. If you die or become permanently disabled, neither you nor your estate will incur a tax bill for debt remission under federal student loan programs.
Your loan is canceled due to fraud or school closure during enrollment. The government provides a tax-free loan forgiveness in cases where you have incurred student loan debt and been the victim of fraud at your school or if your school closed while you were enrolled.

You may also be eligible for state-level loan forgiveness programs that offer tax-free loan forgiveness. Research possible loan forgiveness programs offered by your state and whether you may qualify for a tax-exempt loan forgiveness. You can also consult a tax expert.

How Can I Pay A Tax Bomb For Student Loans?

If you don’t qualify for a federal student loan forgiveness program that offers tax-exempt loan forgiveness, you may need to explain how you can pay for your student loan forgiveness. It means calculate your income taxes with the loan forgiveness factored into your taxable income.

After you’ve estimated your tax bill, you can prioritize saving the money you would otherwise have paid for your canceled loans. This will prevent a cash shortage caused by a student debt tax bomb.

For example, if you’ve signed up for an income-based repayment plan and can reasonably predict that your payments over time won’t result in a full loan repayment, you can estimate your potential loan forgiveness tax bomb.

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