When a debt is cancelled or forgiven, the discharged debt is treated as though it were income to the taxpayer, leading to a tax liability. In some circumstances, however, the forgiveness is tax-free.
Generally, student loan forgiveness is excluded from income if the loan program provides for cancellation of all or part of the debt if the borrower works “for a certain period of time in certain professions for any of a broad class of employers” (26 USC 108(f)). For example, the 25-year forgiveness for loans in the income-contingent repayment and income-based repayment plans and the 20-year forgiveness for loans in the pay-as-you-earn repayment plan is taxable under current law because it does not require employment in a particular profession. On the other hand, the 10-year forgiveness under public service loan forgiveness is tax-free because it requires working full-time in a public service job.
Note that third-party loan forgiveness programs, such as employer-provided forgiveness and loan repayment assistance programs, do not qualify for tax-free treatment even if they require the recipient to work in a particular occupation. A forgiveness program must be a provision of the loan program for the forgiveness to qualify for tax-free treatment.
To be eligible for tax-free forgiveness and cancellation, the student loan must have been made by the federal, state or local government or government agency, certain tax-exempt public benefit corporations, or an educational institution. Refinanced student loans are also eligible in certain circumstances.
The following loan forgiveness and cancellation programs are eligible for tax-free status:
The following loan forgiveness and cancellation programs are not eligible for tax-free status:
If a borrower dies, the death discharge generally does not result in a tax liability for the borrower’s estate. For example, if a student borrower of a Federal Stafford or Federal Grad PLUS loan dies, the discharge of the remaining debt does not result in taxable income. Likewise, if a parent borrower of a Parent PLUS loan dies, the Parent PLUS loan is discharged without yielding taxable income. However, if a Parent PLUS loan is discharged because of the death of the student on whose behalf the loan was borrowed, the cancelled debt must be included as income on the parent’s federal income tax return.
Lenders are required to report cancellation of debt of $600 or more in a single year on IRS Form 1099-C. Borrowers are required to report the amount of cancelled debt on the “Other Income” line of IRS Form 1040, even if the amount is less than $600.
Treatment of student loan forgiveness on state income tax returns varies by state. For example, Pennsylvania excludes student loan forgiveness from income, per Chapter 24: Cancellation of Debt for PA PIT Purposes, PA Personal Income Tax Guide.
Taxpayers cannot double dip. Borrowers cannot deduct the interest portion of a tax-free loan forgiveness or loan repayment assistance program (LRAP) payment under the student loan interest deduction. The regulations for the student loan interest deduction at 26 CFR 1.221-1(g)(2) state, “Denial of double benefit. ... No deduction is allowed under this section for any amount for which an exclusion is allowable under section 108(f) (relating to cancellation of indebtedness).”
There are no income phaseouts on the exclusion from income for student loan forgiveness and cancellation.
The legislation providing an exclusion from income for certain loan forgiveness and cancellation programs does not expire.
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