Who Else Wants Tax Free Student Loan Forgiveness!?!
December 20, 2012

The government’s recently amped up Income-Based Repayment program is a windfall for millions of student loan borrowers. However, there’s an issue accompanying this repayment plan that’s been very much ignored. One of the major benefits of Income-Based Repayment is that it offers the possibility of loan forgiveness after 20 years. Typically, forgiven loans are classified as income and are thus subject to income taxes.

Unlike the staggered repayments borrowers will have been making during those 20 years while working toward loan forgiveness, the resultant income tax will all be due in one chunk payment. This could potentially be harder on borrowers than continuing to make Income-Based Repayments for the rest of their lives. Unless something changes, taxable loan forgiveness might not really feel like loan forgiveness at all.

Income-Based Repayment really is one of the best repayment plans out there for low-income borrowers. The plan offers most borrowers monthly payments amounting to less than 10% of gross income. After 20 years of on-time payments the loan will be forgiven.

The only repayment plan that offers a better deal is Public Service Loan Forgiveness, which measures monthly payments identically to Income-Based Repayment, but makes loan forgiveness available after only 10 years. Here’s the kicker, unlike Income-Based Repayment, Public Service Loan Forgiveness is entirely tax deductible. As the program provides a very broad spectrum of qualifying careers, it might be worthwhile looking into jobs that fit the bill.

This is by no means a call to reject an Income-Based Repayment plan; it’s still a fantastic option for millions of borrowers. The hope is that some attention will begin to be paid to the tax issue that will come up down the road. The repayment plan was first offered in 2009, so the first time borrowers will become eligible for forgiveness will be in 2029.

Thankfully there’s plenty of time to work on getting this issue sorted out before then. And it is starting to get some attention. For instance, in October of this year the New America Foundation published a report examining changes to Income-Based Repayment, in which the nonpartisan public policy institute recommends (among other things) making Income-Based Loan Forgiveness tax-free.

Think about it, without tax forgiveness, a borrower who is forgiven $40,000 in student loans could easily be expected to pay $10,000 worth of income tax on those loans in one year. That’s just not possible for someone making, say, $20,000 per year.

Fortunately too (in addition to having time on our side) there are student aid organizations that offer expertise on how best to manage student debt. With good debt management and foresight, there’s no need to get caught in the crosshairs of unexpected payments down the road.