Tax-Free Student Loan Forgiveness
Tax-Free Student Loan Forgiveness
Loan principal and interest balance
Student loans made by the
government or a college/university
Must work in a specified occupation
Number of Years
Some student loan forgiveness is tax-free and some student loan forgiveness is taxable. Student loan forgiveness is tax-free if the student loan is made through a government or college/university student loan program and the debt is cancelled by the loan program because the borrower worked in one of a specified set of professions for a specified period of time for any of a broad class of employers. However, tax-free student loan forgiveness cannot be in exchange for services performed for the lender, such as employment by the lender.
Normally, the IRS treats cancelled debt as income to the borrower, per 26 USC 61(a)(12). Cancelled debt in excess of $600 is reported on IRS Form 1099-C (instructions). Some types of student loan forgiveness, however, are eligible for tax-free treatment under current federal law, per 26 USC 108(f)(1). (Some states have their own rules for tax-free treatment of student loan forgiveness.) Closed school discharges are not treated as income to the borrower, per 20 USC 1087(c)(4) and 20 USC 1087dd(g)(4). Discharges due to false certification and unpaid refunds are also not treated as income to the borrower, per 20 USC 1087(c).
While tax-free student loan forgiveness does not require the education institution to be accredited or eligible for Title IV federal student aid, most of the eligible student loan programs happen to have such a restriction. Likewise, although there are no enrollment status restrictions, most of the eligible student loans require at least half-time enrollment. Similarly, most of the eligible student loans require the student to have been seeking a degree, certificate or other recognized education credential.
There are no income phase-outs for tax-free student loan forgiveness and the tax-free treatment does not expire.
Eligible loans include loans made by the following organizations:
- Federal, state, county or local government
- Government agencies
- Tax-exempt public benefit corporations that have assumed control over a state, county or municipal hospital
- Educational institutions
For example, the Federal Perkins Loan, Federal Stafford Loan, Federal PLUS Loan and Federal Consolidation Loan are eligible, as are state student loan programs and loans made by a college or university. Certain student loan forgiveness programs, such as public service loan forgiveness, may require the federal loans to be in the U.S. Department of Education’s Direct Loan program.
Private student loans made by commercial lenders are not eligible.
Examples of Tax-Free Student Loan Forgiveness
The following student loan forgiveness programs are tax-free:
- Public Service Loan Forgiveness [20 USC 1087e(m)]
- Teacher Loan Forgiveness [20 USC 1078-10, 20 USC 1087j]
- Loan Forgiveness for Service in Areas of National Need [20 USC 1078-11]
- National Health Service Corps Loan Repayment Program [42 USC 254L-1]
- State education loan repayment and forgiveness programs for providing health care services in underserved and shortage areas [42 USC 254Q-1]
- Student loan repayment programs for employees of federal agencies [5 USC 5379]
- Closed school discharge [20 USC 1087(c)(4) and 20 USC 1087dd(g)(4)]
- False certification discharges (ability to benefit, unauthorized signature/unauthorized payment, identity theft, disqualifying status) [20 USC 1087(c)(1) and (4)]
- Unpaid refund discharge [20 USC 1087(c)(1) and (4)]
- Certain loan forgiveness options for Federal Perkins Loans [20 USC 1087ee]
- Teachers in teacher shortage areas (math, science, foreign languages, bilingual education)
- Teacher in an elementary or secondary school that serves low-income students
- Members of the US Armed Forces (service in a combat pay area)
- Nurses and medical technicians
- Law enforcement or corrections officers
- Public defenders
- Librarians with a master’s degree working in a Title I eligible school or in a public library serving Title I eligible schools
- Speech pathologists with a master’s degree serving Title I eligible schools
- Head Start program employees
- Special education teachers
- Child or family services workers
- Professional providers of early intervention services for the disabled
- Faculty at tribal colleges and universities
- College or university loan repayment assistance programs (LRAP) for service in areas or occupations with unmet need (medicine, nursing, teaching and law), where the service is provided for or under the direction of a governmental unit or tax-exempt 501(c)(3) organization [26 USC 108(f)(2)(D)]
Examples of Taxable Student Loan Forgiveness
The following student loan cancellation programs are taxable because the cancellation is not conditioned on the borrower working in a certain profession for a certain period of time:
- Death discharge
- Total and permanent disability discharge
- Bankruptcy discharge
- Income-contingent repayment (cancellation of the remaining debt after 25 years of payments)
- Income-based repayment (cancellation of the remaining debt after 25 years of payments)
- Pay-as-you-earn repayment (cancellation of the remaining debt after 20 years of payments)
- Revised pay-as-you-earn repayment (cancellation of the remaining debt after 20/25 years of payments)
Student loans that are discharged due to the death of the borrower are not charged against the borrower’s estate. However, the discharged debt is treated like income to the borrower and therefore leads to a tax liability. The U.S. Department of Education has been issuing IRS Form 1099-C when federal student loans are discharged due to death and disability of the borrower.
Thus, the federal government continues to pursue a morally bankrupt policy of taxing the cancellation of student loan debt because of the borrower’s death, disability or inability to repay or because the borrower has successfully repudiated the debt.
Examples of Eligible and Ineligible Loan Programs
Employer student loan repayment assistance programs represent taxable income to the employee under current law because the loan forgiveness is not due to a provision of the loan program.
On the other hand, Tufts University provides a loan repayment assistance program (LRAP) for its alumni who pursue public service jobs. The alumni seek public service loan forgiveness and choose an income-driven repayment plan. Tufts University makes the monthly loan payments on their behalf. These loan payments are structured as a loan to the alumnus. When the alumni qualify for public service loan forgiveness, the LRAP “loan” is forgiven at the same time. Since the LRAP is a loan funded by a college or university to encourage participants to pursue careers in public service, the LRAP is tax-free.
There is no double-dipping. The interest portion of payments under tax-free student loan forgiveness and loan repayment assistance programs is not eligible for the Student Loan Interest Deduction.
A good source of additional information concerning tax-free student loan forgiveness and repayment assistance is Chapter 5 of IRS Publication 970, Tax Benefits for Education. General discussion of cancelled debt can be found in IRS Publication 4681. IRS Revenue Ruling 2008-34 discusses law school loan repayment assistance programs. Information about Student Loan Repayment for Federal Employees can be found on the web site of the U.S. Office of Personnel Management (OPM).
The tax status of student loan forgiveness was discussed in a Sept. 19, 2008 letter to Rep. Sander Levin from Eric Solomon, Assistant Secretary for Tax Policy, U.S. Department of the Treasury.
Statutory language specifying that income includes the discharge of indebtedness appears in the Internal Revenue Code of 1986 at 26 USC 61(a)(12). Statutory language concerning the exclusion from income for certain types of student loan forgiveness appears at 26 USC 108(f). In particular, this section of the Internal Revenue Code provides for tax-free treatment of student loan cancellation "if such discharge was pursuant to a provision of such loan under which all or part of the indebtedness of the individual would be discharged if the individual worked for a certain period of time in certain professions for any of a broad class of employers." Tax-free treatment in connection with the Public Health Service Act can be found at 42 USC 254L-1 and 42 USC 254Q-1.
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