Student Loan Repayment

Having student loan debt isn’t quite as bad owing back taxes, but it’s close. If you have federal student loans in default, you can face the same type of wage garnishment you face with the IRS; they can take money from your paychecks without a court order. The Department of Education also has the right to intercept your tax refund to pay your defaulted loans.

So, it’s important to understand your options for repayment and how those options can potentially impact your taxes. If you’re currently repaying student loans, it’s a good idea to consult with a licensed tax professional. That way, you can make sure you receive all the tax benefits of repayment that are available. You also need to consult a tax professional if you are working towards student loan forgiveness. Some, but not all, paths to loan forgiveness may increase your tax liability in the year the loans are forgiven. You can learn more below or call us for more information if you have questions about your specific situation.

Finding the best way to get out of student loan debt really depends on the types of loans that you have. These types of loans require different strategies for repayment:

1. Federal student loans
2. Private student loans
3. Federal PLUS loans for parents who pay for their children’s schooling

If you have different types of loans, then you may need to use more than one of these solutions. The type of school you attended can also impact the options you have for repayment.

If you have student loans backed by the federal government, then you also have the widest range of options for relief. There are currently five basic types of federal repayment plans that can make it easier to repay your loans. The one you use depends on your budget and repayment goals.

1. This pays off all your federal student loans on a 10-year payment plan.
2. The monthly payments are determined by how much you owe, in total.

1. The term of this plan is also 10 years
2. Every two years, your payments increase by 7%
3. The idea is to start low to match an entry-level salary and then gradually increase to match pay raises through career advancement.

1. The payment amount is based on your family size and Adjusted Gross Income (AGI), which is the same AGI that you use on your income taxes.
2. In most cases you end up paying about 15 percent of your AGI.
3. The term on this plan can be 20-25 years, depending on your total debt.

1. This plan generally offers the lowest payments possible. Most borrowers pay about 10 percent or less of their AGI.
2. If some cases, if you fall below the Federal Poverty Line (FPL) in your state, your payments may be reduced even further.
3. Some borrowers pay nothing without being penalized if their income is low.
4. These plans generally have terms that can go up to 25 years.

If you have student loans through a private lender that aren’t backed by the federal government, then you can’t use any of the options listed above. Instead, your only real option to find relief is to consolidate and refinance your existing student loans with another loan.

You find a lender that will give you a lower interest rate than what you’re paying now. That rate will be based on your credit score, so you’ll need good credit in order to qualify for the lowest rate possible. Then you use the funds you receive from the new loan to pay off your existing loans.

This refinancing option can also be used for federal loans. Once you refinance through a private lender, you’re no longer eligible for any of federal relief options, including student loan forgiveness. So, you need to think carefully before you use private refinancing for federal student loan debt.

If you took out federal PLUS loans for parents to fund your children’s education, then you also have repayment options. You don’t get access to all of the repayment plans listed above for student borrowers. Instead, you’re limited to:

1. A standard parent PLUS loan repayment plan
2. An income-contingent parent PLUS loan repayment plan
3. Private consolidation and refinancing

There is a student loan interest deduction that you can claim on your federal income taxes. The maximum deduction is up to $2,500 per year. The benefit applies to all loans, even if you have private loans. You also receive the benefit for interest payments for your spouse or a dependent.

However, starting in 2018, there were limitations placed on who can qualify for the student loan interest rate deduction. With the new rules:

• If your modified gross adjusted income (MAGI) is between $65,000 and $85,000, then the deduction is gradually reduced; the gradual reduction for joint filings applies for MAGI between $135,000 and $165,000.
• If your MAGI is more than $85,000 as an individual or $165,000 on a joint filing, then you can’t claim the deduction at all.

Aside from repayment plans, there are also options for student loan forgiveness. Some of these options are built into the federal repayment plans described above. For example, if you still have a remaining balance owed when you reach the end of the 25-year term on an income-based repayment plan, that balance is forgiven. This is true of all the hardship-based repayment plans, including income-contingent, income-sensitive, and pay as you earn.

There is also a program called Public Service Loan Forgiveness (PSLF). With this program, you must enroll in one of these repayment plans:

1. Income-based repayment
2. Income-contingent repayment
3. Pay as you earn

Once you enroll, you must make 120 qualified payments through the plan. During that time, you must be working in in the public service sector, so in jobs like teaching, nursing, or working as a first responder. You can certify your employment through StudentAid.gov to make sure you’re working for an organization that will qualify you for forgiveness. After 10 years of repayment and public service work, your remaining loan balances are forgiven.

You’re allowed to switch jobs during the 10-year period, but you must stay in the public service sector. So, for example, if you are a teacher and start working for a private school, that may not qualify. Always go back to StudentAid.gov to recertify your employment anytime you change jobs because you must be working in public service for the entire 10 years to qualify.

While PSLF is the most common and comprehensive student loan forgiveness program, it’s not the only one.

• There are other programs that forgive limited amounts of student loan debt for military service through the Department of Defense.
• Then there’s full student loan forgiveness for Veterans that received a service-related discharge from the military due to a permanent and total disability.
• There is limited student loan forgiveness and cancellation for volunteer work through the VISTA, AmeriCorps and Peace Corps.
• There are also specialized programs for nurses, lawyers, and teachers outside of the PSLF program. For example, teachers who work in low-income districts can receive up to $75,000 in forgiveness through the National Defense Education Act.
• Finally, if your school closes before you can earn your degree, such as with a for-profit vocational school, then you may qualify for forgiveness under school closure discharge. That also applies if you received a false certification from an unaccredited institution.

While getting any student loan forgiveness sounds like it would be nothing but beneficial, not all forgiveness programs are tax exempt. In most circumstances, when a debt is canceled or discharged, it is treated as taxable income. This can increase your tax liability in the year the debt is forgiven. In other words, you have more taxable income, so your tax liability is higher.

This means your tax refund could be reduced or, in some cases, you could end up owing the IRS. Penalties and interest on back taxes stack up quickly, so you want to make sure that you know how student loan forgiveness will impact your taxes for the year.

There are some exceptions for taxes on canceled debt. However, only some student loan forgiveness programs qualify for that exception.

• If you have student loan debt forgiven through the PSLF program, that debt is not treated as taxable income. There is no need to apply for a tax exclusion. The exclusion is applied automatically, and you don’t need to report the canceled debt on your tax returns.
• This also applies to debts forgiven through the other public service program for teachers under the National Defense Education Act.
• On the other hand, debts forgiven for school closures and false certifications are not exempt. The forgiven amount will count as taxable income.
• In addition, if you have remaining balances forgiven at the end of a hardship-based repayment plan, that is also considered taxable income.

One easy way to know if your canceled debt is exempt or not is to simply look for a 1099-C form in the mail. If the debt that was forgiven counts as taxable income, then the lender will mail you a 1099-C that you’re supposed to file with your income taxes. However, you may not want to wait for those forms to come in.

If you can prove that you were insolvent at the time your student loan debt was forgiven, you may be able to qualify for an exclusion. This involves completing an additional form with your taxes that shows your liabilities exceeded your assets. If you can do that, then you may qualify for an exclusion equal to the difference. For example, if you have $15,000 in liabilities and $5,000 in assets, you would qualify for an exclusion up to $10,000.

It's a common myth that student loan debt cannot be discharged by filing for bankruptcy, whether it's federal or private. This is not exactly true. depending on your financial situation, the types of loans you hold and the school you attended.

First, a little history. In 1976, Congress amended the Higher Education Act to make it more difficult to discharge student loans during bankruptcy. The amendment required borrowers to spend five years in repayment and show that their loans were causing undue financial hardship. If those criteria were met, student loans could be discharged through bankruptcy.

In 2005, Congress extended the same protections to cover some private student loans. As long as the loan was used to attend a Title IV school, the same bankruptcy discharge restrictions applied. Loans for attending any school that was not Title IV school were never protected.

From these amendments, it became a commonly held belief that ALL student loan debt was protected from bankruptcy discharge. And that’s not exactly a myth that student loan servicers are going to discourage. People simply came to believe that they can’t discharge student loans during bankruptcy, so they never try.

However, the truth is that you can discharge student loan debt during bankruptcy.

• If you attended a school that wasn’t Title IV and took out private student loans, these are actually fairly easy to discharge.
• If you attended a Title IV school and had private student loans OR you have federal student loans, you can still discharge those debts. You simply need to show your loans create an undue financial hardship on you and your dependents.

To show undue financial hardship, you simply need to pass something known as the Brunner Test. This evaluates your situation based on three factors:

1. Your student loan payments do not allow you and your dependents to maintain a minimal standard of living.
2. Your financial situation is unlikely to improve during the remaining time you have left in repayment.
3. You have made a good faith effort to try and repay your loans.

If you meet all three standards, you can qualify for discharge. Just be aware that you need to find a bankruptcy attorney that's up-to-date with current student loan discharge rules. Not all attorneys are familiar with this process, so you need to find one that is to qualify for discharge.

The IRS grants an automatic exclusion on any debt canceled during bankruptcy. This includes both private and federal student loans. This means that you won’t receive a 1099-C from a student loan servicer if those loans were discharged through bankruptcy.