For the 7 out of 10 people who are working on repaying their student loans, a possible large tax bill on student loan forgiveness can be frightening. It is hard to believe that these borrowers would be faced with a tax given the $1 trillion in outstanding student loan debt, but nothing comes cheap and forgiveness can sometimes not be so forgiving.
The Federal Government offers two types of loan forgiveness options, public service loan forgiveness which is tax-free and income-based repayment plans which are vulnerable to taxation. Income-based repayment plans offer viable solutions to borrowers in the middle class, but they come with a catch.
Those enrolled in income-based repayment (IBR) plans have increased from roughly 5% in 2012 to just under 20% in 2016. Low-income borrowers face upwards of 25 percent of forgiven loans being paid to the IRS. While the number of IBR participants are increasing, these borrowers may be surprised at the tax policies associated with these repayment plans.
Under the income-based repayment plan, borrowers make monthly payments that are derived from a portion of their salary. After a certain time period, the rest of the unpaid loan is forgiven. Even though the remaining loan balance is forgiven, this is not the end of paying back money on the loan.
These taxation policies are not limited to just IBR plans; for instance, taxes are due on some loans excused for reasons such as death or permanent disability. It doesn’t end there, if a student loan borrower’s school closes and he or she receives loan forgiveness, the amount forgiven is still taxable.
In order to receive student loan forgiveness, you must be able to present the ability to make on-time payments. The exact number of payments needed to receive a cancelation of the remaining balance of someone’s loan is 120 monthly payments, while working full time for an employer that must also be approved. The Department of Education, in 2012, created a voluntary form that allows borrowers to keep up with their progress. This has helped lead over 400,000 student loan borrowers to receive eligibility.
Once you complete the steady monthly payment plan offered depending on the program in your state, you will be relieved of any extra balance. From here, you enter into the tax bill stage, where you fill out a form that contains agreements that are most definitely worth following in order to ensure the path towards forgiveness.