It is normal to worry about being slapped with a tax bill for your forgiven student loans -- after all, being free of student loan debt can seem too good to be true. With U.S. student loan debt reaching $1 trillion in 2012, you might think the government has to get some of the money back somehow. For many borrowers, however, student loans are forgiven and the canceled debt won't be taxed.
While most canceled debts are treated as taxable income, some student loan forgiveness programs are exceptions. Student loans can be forgiven, or canceled, if the borrower meets specific criteria. Loans forgiven in return for public service -- including teaching -- may be forgiven. Simply meeting the requirements to have your student loans forgiven, however, does not necessarily mean you will pay no tax on the canceled loan. "Loan discharges for closed schools, false certification, unpaid refunds, and death and disability," notes the website FinAid, "are considered taxable income." Canceled loans totaling more than $600 should be reported on IRS Form 1099-C.
If you had to work to earn student loan forgiveness, chances are good that you will not have to claim the canceled loan as income on your taxes. Loans made by a qualifying lender -- including government sources, tax-exempt organizations or most education institutions -- can be forgiven if you meet certain employment criteria, like working in a specified profession for a specified number of years, and are not taxable. Such treatment generally is used as an incentive to attract employees to work in high need areas or for government and tax-exempt organizations classified by IRS code, section 501(c)(3).
Some canceled loans may or may not be taxable depending on your circumstances. For example, the balance that is forgiven after 25 years of payments on an income-based repayment plan is taxable. It would not be taxable if the borrower also qualifies for forgiveness based on public service during the repayment period.
State tax laws vary. Check with the state with which you file your taxes to determine how your cancelled loan will be treated. Student loans canceled by the lender for work performed for the lender do not receive the same tax treatment. They are generally taxable. If you receive student loan repayment assistance and the payments are made by an eligible health services program, the payments may be tax-free. If you refinance or consolidate student loans with those made by a qualified lender under provisions of an incentive program to attract workers to high-need occupations or to work for the government or a non-taxable organization, the refinanced or consolidated loan is considered as having met qualified lender requirements.
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