THE BLOG
05/27/2016 10:36 am ET Updated May 28, 2017

Understanding Taxable Forgiveness on Your Student Loans

Student loans can be a heavy burden on any borrower struggling to make monthly payments. Thankfully, the Department of Education offers some relief in the form of student loan forgiveness.

Most people know about Public Service Loan Forgiveness (PSLF), which offers tax-free loan forgiveness for borrowers working full-time for government, nonprofit, or public service organizations, once they have made 120 payments. Many don't know that there is another form of taxable loan forgiveness, available under any income-driven repayment plan. Everyone is eligible, regardless of the type of career you choose!

The four income-driven repayment plans--Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR), and Income Contingent Repayment (ICR)--all offer forgiveness of your student loan debt after 20 or 25 years of payments. In addition, these plans will cap your monthly payments at 10-15% of your income.

So what's the catch?

When your remaining balance is forgiven after 20 or 25 years, what's left over on your loans will still be considered taxable income by the Internal Revenue Service (IRS). This means that if you have $40,000 left on your student loans at the time of forgiveness, you could face a federal tax bill of $10,000 or more, depending on your tax bracket.

It's also important to keep in mind that while income-driven repayment plans can offer financial cutbacks on your monthly student loan payments, the reduced amount may not be enough to cover the interest on your loans. By the time you enter forgiveness, your remaining student loan balance may balloon to an even larger amount.

However, there's hope on the horizon for legislative change.

U.S. Representatives Chellie Pingree (D-ME), Peter Roskam (R-IL), Ron Kind (D-WI), and Ryan Costello (R-PA) recently introduced the Stop Taxing Death and Disability Act, a bill that will save families from huge tax bills when federal student loans are forgiven after death or disability.

In 2014, U.S. Representatives Mark Pocan (D-WI) and Frederica Wilson (D-FL) introduced the Relief for Underwater Student Borrowers Act, which would allow student loan borrowers who have been granted debt relief as a result of consistent repayment towards their student loan debt an exemption from being taxed on the amount forgiven.

Last year, Rep. Jim McDermott (D-WA) and 34 other House members also introduced the Student Loan Tax Debt Relief Act, a bill that would make the discharge of student loans in any income-contingent or income-based repayment plan non-taxable.

Despite these steps toward reforming taxable forgiveness policies, none of these bills have been passed. The good news is that 20 or 25 years is a long time to make strides toward modifying the law and providing better financial safety nets for student loan borrowers.

Equal Justice Works can keep you up to speed on all legislative policies affecting income-driven repayment plans: just download our free student debt e-book, Take Control of Your Future, to be notified automatically of all updates.

You can also listen in on one of our monthly student debt webinars, where we provide detailed information about income-driven repayment plans, Public Service Loan Forgiveness, and other federal student debt relief options.

Ashley Matthews is a Program Manager for Law School Engagement & Advocacy, managing the Student Debt and Student Engagement programs. Prior to joining Equal Justice Works, she worked as Communications Manager for Legal Services Corporation, where she helped design strategies to increase congressional awareness of federally funded civil legal aid. She also led the digital content and communications team for PSJD.org, a public service initiative of the National Association for Law Placement (NALP). Ashley received her J.D. from the University of Miami School of Law.