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How Canceling Your Student Loans Can Mess With Your Taxes

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Student loan forgiveness: Yes, it’s a real thing. Whether or not you can actually get it is a bit more complicated. Qualifying for student loan forgiveness (aka discharge or cancellation) depends on a wide variety of factors, including the type of loan you have, when you borrowed and began repaying it, the repayment plan you’re in and the kind of job you’re working while repaying the loan. We’re not going to get into all that here, but if you’re looking into student loan forgiveness, there’s something important you need to know: You could end up with a big tax bill if you receive it.

Why Student Loan Forgiveness Affects Your Taxes

Under the tax code, canceled debt is any debt forgiven or discharged for less than what the borrower owes. The Internal Revenue Service considers the canceled debt income, meaning you must include it ias such when you file your taxes. If your lender forgives a debt of $600 or more, you may receive a 1099-C in the mail, meaning the IRS has been notified of the canceled debt and it should be included in your tax return. Even if you don’t receive a 1099-C, you still need to report the canceled debt to the IRS, and the taxes on that forgiven debt could be a substantial sum, depending on how large your unpaid loan balance was.

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    Because the IRS considers canceled debt income, your income level could increase to a point that you don’t qualify for certain tax deductions and credits, further complicating your taxes. But there’s good news: There are exceptions, including some student loans.

    When You Have to Pay Taxes on Canceled Student Loan Debt

    In the rare situation that you’ve had your student loans discharged in bankruptcy, you could end up having to pay taxes whatever the remaining balance was. However, there’s an insolvency exception to including canceled debt in your income and paying taxes on it: If you were insolvent immediately before your lender canceled your debt, you’d likely qualify for this exception.

    If you’re totally and permanently disabled and had your loans discharged as a result, you may have to declare the forgiven debt as income and pay taxes on it. Again, the insolvency exception could come into play. For private student loan borrowers, the only way you can get your loans forgiven is bankruptcy, disability discharge or a loan settlement (if you can manage to negotiate one). Federal student loan borrowers have a few more options, including income-driven repayment plan forgiveness, closed-school discharge, death of borrower discharge and false loan certification discharge (meaning you legally shouldn’t have qualified for a student loan in the first place). In those situations, you can expect to pay taxes on the forgiven sum.

    When You Don’t Have to Pay Taxes on Canceled Student Loan Debt

    In addition to the insolvency exception, some student loan borrowers may not have to pay taxes on their forgiven loans. If you qualify for student loan forgiveness because of your job, the canceled debt does not add to your income. This includes programs like public service student loan forgiveness (PSLF), teacher loan forgiveness and Perkins loan cancellation received because of your occupation. The IRS goes into more detail on qualifying jobs here, but in general, if your loan forgiveness had anything to do with your job, you’ll want to look into this aspect of the tax code.

    If you’re like most people and find the tax code a little confusing or intimidating, it may be worth your time and money to ask for help preparing your taxes after you’ve had your student loans canceled. Even if you haven’t had your loans forgiven yet but are working toward PSLF (no tax burden) or loan forgiveness through an income-driven repayment plan (yes, you’ll probably have to pay taxes), you’ll want to think ahead so you’re not overwhelmed by the tax implications when the time comes to deal with them.

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