Do I have to pay taxes on canceled student loans?

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The Credible Money Coach shares good news about student loan forgiveness and federal income tax. (Credible)

Dear Credible Money Coach,

i just read [a Fox Business] article on student loan forgiveness. Nothing was said about the amount of the taxable discount. I understand this is counted as income. Am I right? Or am I lucky and this amount is not taxable? —Kay

Hi Kay, and thank you for this great – and timely – question. The idea of ​​not having to repay a debt can be appealing, so it’s easy to forget that the IRS generally classifies forgiven, forgiven, or discharged debts as taxable income. You generally have to report the canceled debt as income on your federal tax return for the year the debt was canceled.

But there are some exceptions, including certain types of student loan debt forgiveness.

If student loan forgiveness isn’t an option, refinancing private student loans can get you a lower interest rate or more manageable monthly payments. Credible makes it easy to compare student loan refinance rates from multiple lenders.

Good news from the US Rescue Plan Act

In response to the current financial crisis caused by the COVID-19 pandemic, the federal government enacted the American Rescue Plan Act in March 2021.

Among its many provisions aimed at supporting the economy, the law temporarily made canceled student loans excluded from gross income for tax purposes. This means that if you have a federal government or private student loan surrendered for any reason between December 31, 2020 and January 1, 2026, you will not have to pay federal income tax on the surrendered amount.

Keep in mind that if your state has its own income tax, it may handle canceled student loan debt differently. The provisions of the law only apply to the Federal Tax Code. That said, many states choose to follow federal tax rules for their own tax codes. If you are unsure of your state tax liability, consult a qualified tax professional.

It should also be noted that not everyone can qualify for student loan forgiveness.

Types of student loan forgiveness

The U.S. Department of Education, which provides federal student loans, allows federal student loans to be forgiven under these programs:

  • School outing closed — If you are enrolled in a school when it closes or closes shortly after leaving school, you may be eligible to have your Direct Loan, Federal Family Education Loan (FFEL), or Perkins loan.
  • Teacher Loan Forgiveness Program — This program, available for direct and FFEL loans, allows educators who have taught full-time for five consecutive college years to have up to $17,500 forgiven provided they spent those years working in an elementary school. or low-income secondary, or educational service agency.
  • Perkins Loan Cancellation or Release — Teachers with Perkins loans may be able to have some or all of their loans forgiven if they work at a school that serves low-income families, as a special education teacher, or teach math, science, foreign language, bilingual education or other area with a shortage of qualified teachers as determined by their state. The amount they can have forgiven depends on their years of service.
  • Disability or bereavement leave — If a borrower becomes totally and permanently disabled, or dies before their loan repayments are complete, their direct, FFEL and Perkins loans may be cancelled.
  • Defense of the borrower until repayment — If your school cheated on you, was at fault, or violated certain state laws, and you took out your loans specifically for the purpose of attending school, you may qualify for this type of federal loan release. .
  • Cancellation of public service loans — Individuals who work full-time for a fixed term in certain public service jobs – typically, for government at any level or for a qualifying non-profit organization – may qualify for a discount under This program. You will need to meet all the conditions, including making a certain amount of payments on an eligible federal student loan.

How Student Loan Forgiveness Normally Affects Taxes

Student loans canceled outside of the temporary US bailout period are generally considered taxable income, except for federal loans canceled under the Civil Service Loan Cancellation Program, the teacher loan forgiveness program and the cancellation of the Perkins loan. If your loan was canceled because your school closed or engaged in wrongdoing, the forgiven amount may also be tax-free.

Forgiveness at the end of a income-contingent reimbursement plan (IDR)or termination for death or disability, is generally subject to federal income tax.

Options if you don’t qualify for student loan forgiveness

Forgiveness isn’t the only way to make a student loan more manageable or get rid of it faster. Depending on your financial situation and the types of student loans you have, an IDR plan, a federal direct consolidation loan, or refinancing with a private student loan may be options.

Just be aware that while refinancing federal student loans into a private loan may allow you to lower your interest rate, reduce your monthly payment, and extend the time you have to repay the loan, you will also lose the benefits of the loan. federal student. If you’re considering refinancing a student loan, it’s a good idea to compare rates. Credible makes it easy to see rates from multiple lenders.

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About the Author: Dan Roccato is a clinical professor of finance at the University of San Diego School of Business, personal finance expert Credible Money Coach, published author and entrepreneur. He has held senior positions at Merrill Lynch and Morgan Stanley. He is a recognized expert in personal finance, global securities services and corporate stock options. You can find it on LinkedIn.

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