Imagine coming home one day, opening your mailbox, and seeing an official-looking envelope from the U.S. Department of Education. Inside, you find a letter stating that your entire federal student loan debt has been forgiven.
While this may seem impossible, it really did happen for 387,000 Americans eligible for a total and permanent disability discharge this year. Federal student loan borrowers who can’t work because of a disability can have their loans forgiven.
While $7.7 billion in student loans will be discharged, or an average of $19,896 per person, that’s not the end of the story for these borrowers.
In fact, they may owe thousands of dollars to the Internal Revenue Service thanks to a student loan forgiveness tax attached to their forgiven debt.
Who qualifies for a TPD student loan discharge?
Paying for student loans can be a struggle for many individuals. But what about student loan borrowers who have a severe disability? For them, it can be nearly impossible.
If you are physically incapable of working for at least five years, the government offers a student loan discharge under the Total and Permanent Disability (TPD) discharge program.
A TPD discharge is only for federal student loans. These include Federal Direct Loans, Perkins Loans, and Federal Family Education Loans (FFEL). It does not impact what you may owe through private student loans.
If you’re a disabled veteran, you must provide a letter from the Veterans Administration stating that you are permanently disabled and unable to work due to a service-connected disability. Then you will qualify for a TPD discharge.
Or, perhaps you are receiving Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) benefits. You can submit a Social Security Administration (SSA) notice of award for SSDI or SSI benefits stating that your next scheduled disability review will be within five to seven years from the date of your most recent SSA disability determination.
Additionally, anyone with a letter from their doctor certifying that they are totally and permanently disabled is eligible to apply for a student loan discharge under the TPD program.
How did President Obama get involved?
However, so many Americans didn’t know about this program that President Barack Obama decided to take action. He instructed the Department of Education to proactively discharge student loans for eligible Americans who had not applied.
The Department of Education matched records with the Social Security Administration database. They then searched for anyone with federal student loans and a Social Security disability status of “Medical Improvement Not Expected.”
Their initial query yielded approximately 387,000 results. Of those 387,000, about 179,000 are currently in default of their federal student loans.
If you default on federal student loans, you’re at risk of social security benefit garnishment, or tax refund garnishment to pay for the loans. Since many of those impacted rely on social security benefits to cover basic necessities like groceries and rent, a garnishment could push them well below the poverty line.
What happens when student loan debt is forgiven?
Within each letter sent to 387,000 permanently disabled Americans with student debt, there was a caveat: a student loan forgiveness tax.
Any student loans that are forgiven are treated like taxable income for that borrower. Unlike a student loan interest tax credit, which lowers your taxes, a student loan forgiveness tax requires paying taxes to the federal government.
Because the student loan amount forgiven is treated as regular income for tax purposes, you pay the same taxes as if you had earned that money at work. It may even bump you into the next income tax bracket.
What’s the tax cost of student loan forgiveness?
Let’s assume that the average person in this program is permanently disabled. And, they only have income from Social Security Disability Insurance.
The average monthly benefit of disability insurance in July 2016 was $1,028.17. That means the average person receiving SSDI at that time has a taxable income of $12,338.04 per year. Such a low income would make it extremely difficult for these individuals to pay back their student loans.
Additionally, if a person with that low of income paid an average of $1,395 in federal income taxes (not including state taxes), their income would be brought down further: $10,943 per year.
Now let’s assume that person has the average student loan balance being forgiven in the program: $19,896. That increases their taxable income to $32,234. Even though they really only brought in $12,338.
With this higher taxable income, their federal income taxes increase to about $4,373. Now they have to pay $4,373 in taxes on $12,338 worth of income. This leaves them with $7,965 to live on for the year. Hardly a livable income.
But remember, $19,896 is the average student loan balance. That means some may have much lower balances while others may have much higher balances.
Is student loan forgiveness tax relief on the horizon?
All hope is not lost for these disabled student loan borrowers faced with the big student loan forgiveness tax.
A bipartisan group of U.S. Senators introduced a bill in April 2016 titled “Stop Taxing Death and Disability Act.” It would eliminate a student loan forgiveness tax for Americans with permanent disabilities.
Although the bill is a long way from becoming law, it could provide relief for those unable to afford to pay a student loan forgiveness tax.
Whatever happens next, taxes on student loan forgiveness are a serious matter. Student loans are usually only forgiven for those in the worst financial situation. However, student loan forgiveness taxes can turn that monetary blessing into a tax curse.
Until the laws are changed, tax on student loan forgiveness lives on. So be sure to read up on all the pros and cons of receiving student loan forgiveness before accepting it.
Interested in refinancing student loans?Here are the top 6 lenders of 2018!
|Lender||Variable APR||Eligible Degrees|
|Check out the testimonials and our in-depth reviews!
1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 5.87% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 5.87% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at email@example.com, or call 888-601-2801 for more information on ourstudent loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
Savings example: average savings calculated based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were disclosed. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
Application detail: 5 minutes indicates typical time it takes to complete application with applicant information readily available. It does not include time taken to provide underwriting decision or funding of the loan.
Instant rates mean a delivery of personalized rates for those individuals who provide sufficient information to return a rate. For instant rates a soft credit pull will be conducted, which will not affect your credit score. To proceed with an application, a hard credit pull will be required, which may affect your credit score.
Total savings calculated by aggregating individual average savings across total borrower population from 9/2013 to 12/2017. Individual average savings calculation based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were provided. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.47% – 6.99%3||Undergrad & Graduate||Visit SoFi|
|2.47% – 5.87%1||Undergrad & Graduate||Visit Earnest|
|2.47% – 8.03%4||Undergrad & Graduate||Visit Lendkey|
|2.95% – 6.37%2||Undergrad & Graduate||Visit Laurel Road|
|2.48% – 6.25%5||Undergrad & Graduate||Visit CommonBond|
|2.72% – 8.32%6||Undergrad & Graduate||Visit Citizens|