You Need to Know How Student Loan Forgiveness Is Taxed

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Student loans are notoriously difficult to escape, but there are some situations where student loan forgiveness can happen. Teachers, government employees, and members of other programs may be able to apply for student loan forgiveness.

But there’s a catch. When student loans are forgiven, borrowers may be surprised to see a big tax bill at the end of the year.

This topic is currently in flux, as there are proposals to make student loan forgiveness tax free. But for now, let’s look at the question: When is student loan forgiveness taxable?

What situations allow student loan forgiveness?

Unless you’re part of a qualified program (most commonly available for teachers and government employees), you typically cannot have your student loans forgiven or discharged. Even in bankruptcy, it is nearly impossible to have student loans canceled.

You could have your federal student loans forgiven if:

  • Your school closes
  • You become severely disabled or die
  • You declare bankruptcy (in rare cases)
  • Your eligibility was falsely certified
  • You withdraw from school, but your school didn’t refund the proper amount to the lender
  • You are a teacher or work in a public service career
  • Your school committed fraud or misrepresented its services

As you can see, the options for student loan forgiveness are very limited. If you do qualify, however, it’s important to understand the tax implications of student loan forgiveness.

Is student loan forgiveness taxable?

For most taxes, you have to earn real income. Most commonly, this happens with your job. You are paid a certain amount of money, and you pay a percentage of that to the government. With student loan forgiveness, the amount forgiven can be treated (and taxed) as regular income.

Let’s say you are not married, earn $40,000 per year as a teacher, and have $50,000 in student loans. Earning $40,000 per year, your top tax rate is 25 percent. Because of how tax brackets work, you would not actually pay 25 percent of your total income. Your tax bill would be $5,771.25 with an effective tax rate of 14.4 percent.

But in that same year, you get your $50,000 remaining student loan balance forgiven. According to the current tax code, that $50,000 is treated as income, more than doubling your taxable income from $40,000 to $90,000. Thanks to saving $50,000, the IRS treats it like you actually earned $50,000 extra. So you have to pay taxes on that “income.”

Now, your taxes paid would be $18,271.25 with an effective tax rate of 20.3 percent. But you never got paid that $50,000, so it’s really like you have an effective tax rate of nearly 50 percent!

If this seems unfair to you, you’re not alone. Someone earning $40,000 per year may already be struggling financially. Add on an extra $10,000+ in student loan forgiveness tax, and that person is hardly scraping by.

There is one current exception to this rule: insolvency.

Insolvency and student loan forgiveness tax

When student loans are forgiven, you’re issued a form 1099C, which includes the amount of forgiven taxes to be included as income. But there is an exception for people who are considered to be “insolvent.”

Insolvency means your total liabilities are more than your total assets. If you are insolvent immediately before your loans are forgiven, you may have a loophole that allows you to lower your tax bill.

Let’s say Zack has $3,000 in the bank, a car worth $5,000, and $10,000 in retirement savings. He also has $15,000 in credit card debt, a $5,000 auto loan, and $20,000 in student loans.

His current net worth is his assets ($18,000) minus his liabilities ($40,000), giving him a net worth of -$22,000. If his $20,000 student loans are forgiven, he is still insolvent with a net worth of -$2,000.

In this case, because Zack is insolvent both before and after the loan forgiveness, he is off the hook and does not have to pay any income taxes on his student loan forgiveness.

Down the hall from Zack, his neighbor Wendy has $40,000 in assets and $60,000 in liabilities, of which $30,000 is student loans. Before her student loans are forgiven, Wendy is insolvent by $20,000, but after the loans are forgiven, she has a positive net worth of $10,000.

If her loans are forgiven, her solvency position is changed from -$20,000 to +$10,000. The “income” on the starting insolvent position is not taxable, but the remaining $10,000 is taxable.

Upstairs in the corner penthouse, lawyer Vanessa has $300,000 in assets and $150,000 in liabilities, of which $75,000 are student loans. Because she is solvent both before and after her $75,000 student loans are forgiven, the entire $75,000 is taxable.

Consult an expert if you face loan forgiveness

As you can see from the examples, this is complicated stuff. If you are in a position to have your student loans forgiven, you could end up with a massive tax bill or a very small one. The deciding factor is your net worth and how much is being forgiven.

To make sure you are on the up-and-up with the IRS, you are best served by working with a tax expert to make sure your tax bill is both correct and as low as possible. A trip to the accountant might sound expensive, but it could save you thousands in student loan forgiveness taxable income. That’s an investment well worth the cost.

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1 Important Disclosures for Laurel Road.

Laurel Road Disclosures

  1. VARIABLE APR – APR is subject to increase after consummation. The variable interest rates are based on a Current Index, which is the 1-month London Interbank Offered Rate (LIBOR) (currency in US dollars), as published on The Wall Street Journal’s website. The variable interest rates and Annual Percentage Rate (APR) will increase or decrease when the 1-month LIBOR index changes.

2 Important Disclosures for SoFi.

SoFi Disclosures

  1. Student Loan RefinanceFixed rates from 3.999% APR to 7.804% APR (with AutoPay). Variable rates from 2.480% APR to 7.524% APR (with AutoPay). Interest rates on variable rate loans are capped at either 8.95% or 9.95% depending on term of loan. See APR examples and terms. Lowest variable rate of 2.480% APR assumes current 1 month LIBOR rate of 2.07% plus 0.91% margin minus 0.25% ACH discount. Not all borrowers receive the lowest rate. If approved for a loan, the fixed or variable interest rate offered will depend on your creditworthiness, and the term of the loan and other factors, and will be within the ranges of rates listed above. For the SoFi variable rate loan, the 1-month LIBOR index will adjust monthly and the loan payment will be re-amortized and may change monthly. APRs for variable rate loans may increase after origination if the LIBOR index increases. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account. *To check the rates and terms you qualify for, SoFi conducts a soft credit inquiry. Unlike hard credit inquiries, soft credit inquiries (or soft credit pulls) do not impact your credit score. Soft credit inquiries allow SoFi to show you what rates and terms SoFi can offer you up front. After seeing your rates, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit inquiry. Hard credit inquiries (or hard credit pulls) are required for SoFi to be able to issue you a loan. In addition to requiring your explicit permission, these credit pulls may impact your credit score
  2. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Financing Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)

3 Important Disclosures for CommonBond.

CommonBond Disclosures

  1. Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). The following table displays the estimated monthly payment, total interest, and Annual Percentage Rates (APR) for a $10,000 loan. The Annual Percentage Rate (APR) shown for each in-school loan product reflects the accruing interest, the effect of one-time capitalization of interest at the end of a deferment period, a 2% origination fee, and the applicable Repayment Plan. All loans are eligible for a 0.25% reduction in interest rate by agreeing to automatic payment withdrawals once in repayment, which is reflected in the interest rates and APRs displayed. Variable rates may increase after consummation. All variable rates are based on a 1-month LIBOR assumption of 2.08% effective July 25, 2018.

4 Important Disclosures for Citizens Bank.

Citizens Bank Disclosures

  1. Education Refinance Loan Rate DisclosureVariable rate, based on the one-month London Interbank Offered Rate (“LIBOR”) published in The Wall Street Journal on the twenty-fifth day, or the next business day, of the preceding calendar month. As of August 1, 2018, the one-month LIBOR rate is 2.07%. Variable interest rates range from 2.72%-8.17% (2.72%-8.17% APR) and will fluctuate over the term of the borrower’s loan with changes in the LIBOR rate, and will vary based on applicable terms, level of degree earned and presence of a cosigner. Fixed interest rates range from 3.50%-8.69% (3.50% – 8.69% APR) based on applicable terms, level of degree earned and presence of a cosigner. Lowest rates shown require application with a cosigner, are for eligible, creditworthy applicants with a graduate level degree, require a 5-year repayment term and include our Loyalty discount and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty and Automatic Payment Discount disclosures. The maximum variable rate on the Education Refinance Loan is the greater of 21.00% or Prime Rate plus 9.00%. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change. Please note: Due to federal regulations, Citizens Bank is required to provide every potential borrower with disclosure information before they apply for a private student loan. The borrower will be presented with an Application Disclosure and an Approval Disclosure within the application process before they accept the terms and conditions of their loan.
  2. Federal Loan vs. Private Loan Benefits: Some federal student loans include unique benefits that the borrower may not receive with a private student loan, some of which we do not offer with the Education Refinance Loan. Borrowers should carefully review their current benefits, especially if they work in public service, are in the military, are currently on or considering income based repayment options or are concerned about a steady source of future income and would want to lower their payments at some time in the future. When the borrower refinances, they waive any current and potential future benefits of their federal loans and replace those with the benefits of the Education Refinance Loan. For more information about federal student loan benefits and federal loan consolidation, visit http://studentaid.ed.gov/. We also have several resources available to help the borrower make a decision at http://www.citizensbank.com/EdRefinance, including Should I Refinance My Student Loans? and our FAQs. Should I Refinance My Student Loans? includes a comparison of federal and private student loan benefits that we encourage the borrower to review.
  3. Citizens Bank Education Refinance Loan Eligibility: Eligible applicants may not be currently enrolled, must be in repayment of their existing student loan(s) and must make the minimum number of payments after leaving school. Primary borrowers must be a U.S. citizen, permanent resident or resident alien with a valid U.S. Social Security Number residing in the United States. Resident aliens must apply with a co-signer who is a U.S. citizen or permanent resident. The co-signer (if applicable) must be a U.S. citizen or permanent resident with a valid U.S. Social Security Number residing in the United States. For applicants who have not attained the age of majority in their state of residence, a co-signer will be required. Citizens Bank reserves the right to modify eligibility criteria at anytime. Interest rate ranges subject to change. Education Refinance Loans are subject to credit qualification, completion of a loan application/consumer credit agreement, verification of application information, certification of borrower’s student loan amount(s) and highest degree earned.
  4. Loyalty Discount Disclosure: The borrower will be eligible for a 0.25 percentage point interest rate reduction on their loan if the borrower or their co-signer (if applicable) has a qualifying account in existence with us at the time the borrower and their co-signer (if applicable) have submitted a completed application authorizing us to review their credit request for the loan. The following are qualifying accounts: any checking account, savings account, money market account, certificate of deposit, automobile loan, home equity loan, home equity line of credit, mortgage, credit card account, or other student loans owned by Citizens Bank, N.A. Please note, our checking and savings account options are only available in the following states: CT, DE, MA, MI, NH, NJ, NY, OH, PA, RI, and VT and some products may have an associated cost. This discount will be reflected in the interest rate disclosed in the Loan Approval Disclosure that will be provided to the borrower once the loan is approved. Limit of one Loyalty Discount per loan and discount will not be applied to prior loans. The Loyalty Discount will remain in effect for the life of the loan.
  5. Automatic Payment Discount Disclosure: Borrowers will be eligible to receive a 0.25 percentage point interest rate reduction on their student loans owned by Citizens Bank, N.A. during such time as payments are required to be made and our loan servicer is authorized to automatically deduct payments each month from any bank account the borrower designates. Discount is not available when payments are not due, such as during forbearance. If our loan servicer is unable to successfully withdraw the automatic deductions from the designated account three or more times within any 12-month period, the borrower will no longer be eligible for this discount.
  6. Co-signer Release: Borrowers may apply for co-signer release after making 36 consecutive on-time payments of principal and interest. For the purpose of the application for co-signer release, on-time payments are defined as payments received within 15 days of the due date. Interest only payments do not qualify. The borrower must meet certain credit and eligibility guidelines when applying for the co-signer release. Borrowers must complete an application for release and provide income verification documents as part of the review. Borrowers who use deferment or forbearance will need to make 36 consecutive on-time payments after reentering repayment to qualify for release. The borrower applying for co-signer release must be a U.S. citizen or permanent resident. If an application for co-signer release is denied, the borrower may not reapply for co-signer release until at least one year from the date the application for co-signer release was received. Terms and conditions apply.
  7. Average savings based on 18,113 actual customers who refinanced their federal and private student loans through our Education Refinance Loan between January 1, 2017 and December 31, 2017. The calculation is derived by averaging the monthly savings of Education Refinance Loan customers whose payments decreased after refinancing, which is calculated by taking the monthly student loan payments prior to refinancing minus the monthly student loan payments after refinancing. The borrower’s savings might vary based on the interest rates, balances and remaining repayment term of the loans they are seeking to refinance. The borrower’s overall repayment amount may be higher than the loans they are refinancing even if their monthly payments are lower.
2.57% – 5.87%Undergrad
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2.80% – 6.38%1Undergrad
& Graduate
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2.48% – 7.52%2Undergrad
& Graduate
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2.47% – 7.99%Undergrad
& Graduate
Visit Lendkey
2.57% – 6.65%3Undergrad
& Graduate
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2.72% – 8.17%4Undergrad
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Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality and will make a positive impact in your life. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print understand what you are buying, and consult a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time. Please do your homework and let us know if you have any questions or concerns.