loan. Such programs are usually tax-exempt, but check with the program’s operator or a tax professional to understand your liability. If you have a forgiven student loan, you should receive a cancellation of debt form, known as Form 1099-C, for your taxes. HOW MUCH WILL YOU PAY? The size of a student loan tax bomb depends on the amount forgiven as well as your finances overall. In some instances, the forgiven student loan could push you into a higher tax bracket — further increasing your tax burden. For example, say you’re married, file taxes jointly and have two dependents. If your taxable income was $100,000 and you claimed the standard deduction, you would fall in the 12% tax bracket and owe $4,684 in taxes. But let’s say you also had $50,000 in student loans forgiven. That additional income would move your federal return into the 22% tax bracket, increasing your tax bill to $15,349 — a $10,665 difference. That additional income may also affect your state taxes. Some states don’t have income tax, and Minnesota, for example, does not tax amounts forgiven under income-driven repayment plans. Check with a tax professional about your situation.
HOW TO PREPARE FOR A FORGIVENESS TAX BOMB
If you don’t think you’ll fully repay your loan over a 20- or 25-year term, use that time to prepare for the fallout of a potential tax bomb. ESTIMATE YOUR BILL. Use the Loan Simulator at studentaid.gov to project your loan forgiveness amount. Tax brackets can change over time, but looking at your earning potential with data from the Bureau of Labor Statistics can help you at least estimate how much you’ll eventually owe. CHOOSE THE RIGHT PLAN. When deciding between income-driven plans, many factors matter, like your degree and marital status. Revised Pay As You Earn, or REPAYE, can make the most sense if eventual forgiveness is likely. This plan offers the best interest subsidy, which can help keep your balance from ballooning. PRIORITIZE SAVING. Instead of paying extra toward your loan, invest money with your forgiveness tax bomb in mind. For example, set aside $50 a month for your eventual bill. That small amount may not make a dent in your loans, but after 25 years with just 2% compound interest, you’ll have saved more than $19,600 — hopefully enough for your tax bill. A savings goal calculator can help you determine how much to put aside.
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