Regardless of how much money you decide to borrow or from what source, student loans are not taxable income. The reason this money isn’t reported as taxable income is that you’re expected to pay the money back at some point, meaning that you aren’t just pocketing the money for personal gain. However, it’s important to note that if your student loan debt is forgiven, the amount that’s forgiven is considered taxable income.
Why Aren’t Student Loans Considered Taxable Income?
Even though you don’t use student loans to buy a tangible asset such as a car, home, or boat, they function just like any other loans. For example, if you borrowed $250,000 to buy a home, you wouldn’t report that on your income tax return. The reason this money is exempt from taxes is that you’ve signed a legal document that states you’ll pay the money back with any interest.
For federal student loans, this interest rate varies from 4.45 percent to 7 percent. You don’t have to pay taxes on student loan interest, either, and in many cases, this interest is tax-deductible once you graduate from college.
Do I Owe Taxes if My Student Loan Is Forgiven?
There are several scenarios where your student debt may be forgiven. While this seems like a pretty solid deal, don’t forget that the forgiven amount becomes taxable income. These taxes come due in the year the loan is forgiven, although the IRS can work out payment plans if you can’t afford the taxes on the amount due.
If you applied for and received an Income-Driven Repayment Plan, it can often seem like a godsend. This caps your monthly student loan payment at 10 to 15 percent after graduation. If you continue to make the payments each month for either a 20-year or 25-year period, the remaining amount owed is forgiven. However, this plan is only available for federal student loan holders.
The problem with this is that you’ll receive a 1099-C form for cancellation of debt, or COD, from the federal lender. The amount stated as forgiveness then becomes taxable income. For a debt forgiveness of $50,000, you could owe as much as $12,500 based on the 2017 tax brackets, and that doesn’t even include any state or local taxes you might have to pay.
In 2016, legislators unveiled the Relief for Underwater Student Borrowers Act. The intention of this act was to eliminate taxes on forgiven debt for those with student loans. The act hasn’t passed, but it also hasn’t been rejected. That’s what makes this act a good one to keep an eye on.
Taxes are no joking matter, and any indiscretion when filing can lead to an audit from the IRS. With the prospect of finding a job and paying off your student loans, you don’t want the time and headache of dealing with this scenario. If you’re ever in doubt, contact a tax professional to help you with any questions you may have.