Taxes & Student Loan Forgiveness

Tax Article ImageNot everyone knows this, but taxes and student loans are intertwined. Student loan interest can be deducted from your taxes, but your tax returns can also have implications on your monthly student loan payments if you are enrolled in an income-driven repayment (IDR) plan. Many borrowers are enrolled in income-driven repayment plans. The most popular reasons for enrolling in IDR include public service loan forgiveness, income-driven repayment forgiveness, or temporarily lowering payments.

GradFin’s Tax Planning and Preparation service helps clients navigate their taxes and repayment strategies. Kyle Murphy, GradFin student loan and tax consultant explains, “An income-driven repayment plan sets your monthly student loan payment at an amount that is intended to be affordable based on your income and family size. There are several different income-driven repayment plans available for your federal student loans, including the Revised Pay As You Earn (REPAYE) plan, Pay As You Earn (PAYE) plan, Income-Based Repayment (IBR) plan, and Income-Contingent Repayment (ICR) plan. These plans have different eligibility requirements depending on when the federal loans were taken out.”

IDR plans are only available to borrowers with federal student loans. Private loans are loans that were taken out from private lenders or refinanced to those lenders. Private loans tend to have more variable interest rates than federal loans, so refinancing private loans to a lower interest rate is often the optimal strategy for managing student loan debt efficiently. Federal loans can also be refinanced to private lenders, which is also often the optimal strategy for borrowers who are not pursuing student loan forgiveness.

Some federal student loans are eligible for student loan forgiveness. Public Service Loan Forgiveness (PSLF) is the most cost-effective forgiveness plan for eligible borrowers. To have your loans forgiven under PSLF, you must make 120 qualifying monthly payments (10 years of payments) under an income-driven repayment plan while working for either a non-profit or a government entity. After 120 qualifying payments, the remainder of your direct federal loans will be forgiven tax-free.

Additional income-driven repayment forgiveness is available for borrowers who do not work for a non-profit or a government entity. Borrowers can qualify for forgiveness of eligible federal loans after 20 or 25 years of qualifying monthly payments, depending on the income-driven repayment plan they are enrolled in. However, this forgiveness is taxable.

“Any amount of federal loans forgiven under the income-driven repayment plan will be included in your income for the year in which it is forgiven, and thus you will pay taxes on that amount,” explains Kyle. Due to the taxable nature of the forgiveness and the extended period of time, forgiveness under an income-driven repayment plan is not as attractive as the PSLF program. However, it can still be the most cost-effective choice for some borrowers.

For more information, schedule a free consultation with a GradFin student loan and tax expert to discuss how we can help you navigate student loan forgiveness and how your taxes can affect your monthly student loan payments.