Graduating college can be one of the greatest moments in your life. One of your not-so-great moments is when you get your first student loan payment. If you are paying back student loans it can be overwhelming. Before you make your first loan payment or try to apply for loan forgiveness, make sure you’ve done your research and you know the tax consequences of repaying or not repaying.
The Advantages of Paying Your Student Loans
While the tax break might not be as large as the one you get when buying a house, you do get a deduction for paying off your loans. You can deduct some of your student loan interest on your federal tax return. This deduction applies to all loans that are used to pay for higher education purposes. You can deduct up to $2,500 of student loan interest paid in a year. If someone else makes a payment on your behalf, you may still be able to claim the deduction because it is usually treated as though you made the payment. You can learn more about the student loan deduction here.
You Could Lose Your Tax Refund If You Don’t Pay
If you default on your loans or don’t pay what you currently owe, up to 100% of your federal tax refund may be taken to satisfy your debt. According to the Federal Reserve, borrowers have accumulated $1.48 trillion in student loan debt. While most borrowers pay their loans back, about 11% of borrowers default and others find student loan forgiveness.
If You Do Not Pay You May Have to Claim the Debt as Income
If you don’t pay what you owe and you have some of that debt written off or forgiven, you must claim that amount written off as income. Under our current tax system, canceled debt is treated as if someone wrote you a check. This will also affect anyone responsible for your loan like a parent or cosigner. The canceled debt income claim not only applies to student loans, it also applies to other debt like credit card debt and mortgages.
Your lender may decide at some point you’re simply not going to pay, this is known as an “identifiable event” by the IRS and happens when a lender believes you cannot pay all that you owe. This could be the result of an agreement, by contract or by legal action.
You May Claim an Exemption or an Exclusion
Before you get too excited, the exceptions and exclusions in the Tax code are limited for student loan forgiveness. The tax laws are written in a way that limits the options you have. A common exclusion that is available is insolvency. If just before your debt was canceled you were insolvent, you can exclude the debt from your income. You are generally insolvent if the totals of all your liabilities was more than the value of all your assets immediately before your debt was canceled. You can use the insolvency worksheet to see if this applies to you.
Forgiveness Under Certain Federal Loan Programs Is Excludable.
If your student loan is forgiven as the result of a qualified program, that debt forgiveness isn’t included in your income for tax purposes. To qualify, your loan must have been made by the federal, state or local government, certain tax-exempt public benefit corporations, or an educational institution. You usually are required to get a job or service in an area with unmet needs to qualify. You can learn more about the programs here.
Paying back your debt can be difficult and so can the tax implications that come with it. If you need help deciding what’s the best plan for you, Polston Tax Can Help. Call us today at 844-841-9857 or click below for a free consultation.