Taxability of Student Loan Forgiveness
Some loan forgiveness programs are taxable and some are not. Under current law, the amount forgiven generally represents taxable income for income tax purposes in the year it is written off. There are, however, a few exceptions. Generally, student loan forgiveness is excluded from income if the forgiveness is contingent upon the student working for a specific number of years in certain professions.
Public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs and the National Health Service Corps Loan Repayment Program are not taxable. Loan discharges for closed schools, false certification, unpaid refunds, and death and disability are considered taxable income. The forgiveness of the remaining balance under income-contingent repayment and income-based repayment after 25 years in repayment is considered taxable income.
Section 61(a)(12) of the Internal Revenue Code of 1986 (IRC) specifies that gross income includes income from the discharge of indebtedness of $600 or more in any calendar year. However, IRC Section 108(f) specifies conditions under which student loan forgiveness is excluded from income. Specifically, IRC section 108(f)(1) states that
In the case of an individual, gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of any student loan 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.
A "student loan" is defined in IRC section 108(f)(2) as including any loan provided to help an individual attend an educational institution. The loan must have been made by the United States or a US agency, a state government (including US territories and possessions and the District of Columbia) or any political subdivision of a state government, or a 501(c)(3) charitable organization that controls a public hospital. Loans made by educational institutions also fall within the definition of a student loan, provided that either the funds came from one of the other three sources or the loan was made under a repayment assistance program of the educational institution that is designed to encourage the institution's students to serve in occupations or areas with unmet needs. The service must be for or under the direction of a governmental unit or tax exempt 501(c)(3) charitable organization. The student must not be employed by or providing service to the educational institution that is discharging the student loan. Forgiveness of refinanced student loans are also eligible for tax free treatment under certain circumstances.
(The inclusion of loans forgiven by tax-exempt charitable organizations was added by the The Taxpayer Relief Act of 1997.)
IRC section 108(f)(4) also excludes from income any payments received under the National Health Service Corps Loan Repayment Program and similar state loan repayment programs. (See sections 338B(g) and 338I of the Public Health Service Act.)
There are no income limitations or phaseouts on the tax treatment of student loan forgiveness.
IRS Revenue Rulings
The US Treasury reviewed several different types of student loan forgiveness and loan cancellation provisions in a September 19, 2008 letter to Representative Sander Levin.
The letter specifies that the following types of student loan forgiveness are not taxable:
On the other hand, the letter also specifies that the following other types of student loan discharges do represent taxable income:
Note that the forgiveness associated with the income-contingent repayment (ICR) and income-based repayment (IBR) programs can be excluded from income in certain situations and is taxable in others. The balance remaining after 25 years of repayment under ICR and IBR is forgiven. This forgiveness is taxable because it does not require employment in a particular profession. However, public service loan forgiveness, which forgives the remaining balance after 10 years in repayment under ICR and/or IBR, is excluded from income because the borrower must repay the loans while employed full-time in public service.
Although the letter does not evaluate the following loan forgiveness programs, they would appear to also qualify depending on who provides the cancelation:
IRS Revenue Ruling 2008-34 determined that most law school loan repayment assistance programs satisfy the requirements of IRC section 108(f) and hence are not taxable.
Cancellation of student loan debt of $600 or more in a single calendar year is generally reported on IRS Form 1099-C.
State Income Tax Treatment
Individual states may have different treatments of loan forgiveness for state income tax purposes. For example, Pennsylvania does not treat loan forgiveness as taxable income. See Cancellation of Indebtedness Student Loan Forgiveness, Pennsylvania Personal Income Tax, PIT-00-093, July 12, 2000.
See Chapter 5 of IRS Publication 970 for more information.
There are proposals to make other forms of student loan forgiveness non-taxable, such as the forgiveness of income-contingent repayment balances after 25 years, but none have become law yet. The general public policy trend is toward excluding from income any forgiveness for individuals who would be unable to pay the taxes on the forgiveness.
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