Should You Worry About a ‘Student Loan Forgiveness Tax Bomb’?
BY RYAN LANE
A “student loan forgiveness tax bomb” happens when your loan balance is forgiven and you must pay taxes on that amount. This primarily affects borrowers on income- driven repayment plans. In this situation, you may face a potentially large tax bill that’s due in full immediately. The best way to prepare for this is to estimate your projected student loan forgiveness and set aside money early for that future tax bomb. WHO FACES A STUDENT LOAN TAX BOMB? Borrowers who use income-driven repayment plans are most likely to experience a student loan forgiveness tax bomb. These plans last 20 or 25 years, and if you don’t pay off your loan during that term, your remaining balance is forgiven — but taxed as income. If you receive forgiveness under a different federal student loan program, it will likely be tax- exempt. You won’t face a tax bomb in the following situations: YOU WORK FOR A QUALIFYING EMPLOYER. Amounts forgiven through Public Service Loan Forgiveness and Teacher Loan Forgiveness, as well as the National Health Service Corps Loan Repayment Program and similar repayment programs, aren’t taxable. YOU DIE OR BECOME TOTALLY AND PERMANENTLY DISABLED. This applies to you or the student benefitting from the loan, in the case of parent PLUS loans. In instances of a death discharge, your estate won’t be taxed. YOU QUALIFY FOR A DIFFERENT FEDERAL STUDENT LOAN DISCHARGE. Loans can be discharged tax-free in instances in which your school defrauded you or closed while you were enrolled, for example. YOUR PERKINS LOANS ARE CANCELED. If you taught or performed other employment or volunteer service that qualified for Perkins loan cancelation, you won’t be taxed on this amount. Many states offer their own student loan forgiveness programs. For example, the Maine Dental Education Loan program offers eligible dentists up to $20,000 annually as a forgivable
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