Student Loan Forgiveness: Taxable or Tax-Free?
Paying back a veterinary school student debt load can be extremely stressful and confusing, particularly when we see yet another news headline with a proposal to eliminate student loan forgiveness.
Analyzing the various federal repayment options and programs and choosing the best for your situation is challenging. Spending nearly the last ten years helping veterinary students, veterinarians, and those who work with them navigate their student loans and repayment options, we’ve seen student loan forgiveness and the debates around it cause significant confusion. First, make sure you understand the differences between Public Service Loan Forgiveness and the taxable forgiveness under income-driven repayment.
Public Service Loan Forgiveness:
Public Service Loan Forgiveness (PSLF) is a federal student loan provision that resonates with many veterinary students and veterinarians. This is a benefit provided under the College Cost Reduction and Access Act of 2007, establishing a pathway to have certain student loans forgiven tax-free after ten years of qualifying payments.
The first eligible payments could have been made starting in October 2007. That means we have passed the ten-year threshold where people can have their student loans forgiven tax-free under PSLF. The early returns have not been encouraging, however they are slightly improving. Of the 109,932 borrowers who have applied for PSLF, 1,139 have been granted the tax-free loan forgiveness.
If you were one of the people who applied unsuccessfully for PSLF or recently learned that you may have been using the wrong repayment plan to qualify for PSLF, then be sure to look into Temporary Expanded Public Service Loan Forgiveness.
The low first-round PSLF qualification rate was not a surprise for those who follow the student loan repayment landscape closely. Knowing whether or not you were making qualifying PSLF payments was nearly impossible in the early years of the provision. If you are working towards PSLF, make sure that you are submitting a Public Service Loan Forgiveness Employment Certification Form at least each year or whenever you change employers.
Avoid these common concerns and pitfalls when it comes to PSLF:
“They are eliminating Public Service Loan Forgiveness so why should I bother trying?”
The current administration has proposed eliminating PSLF and reducing the number of income-driven repayment options for the last three years. The White House always releases a budget in early February, regardless of party or agenda. Then Congress always responds with a different budget, regardless of party or agenda. The White House cannot eliminate PSLF or existing income-driven repayment options without Congressional approval.
Additionally, the proposals to change PSLF and income-driven repayment have included language which essentially leaves the existing options unchanged and creates a new contract for those “new borrowers” who have not yet received federal student loans. That means it is highly unlikely that anyone with an existing federal student loan repayment contract (master promissory note) will see any changes to their current repayment options and benefits.
For those who are worried about their options: read your current master promissory note, review your repayment options, check with your loan servicer on your income-driven repayment and/or PSLF progress, and simulate your remaining costs using the VIN Foundation Student Loan Repayment Simulator.
If you would like to clarify the importance of PSLF and income-driven repayment to you or voice your concerns, then reach out to your congressional representatives (two senators and one house representative) about the process, and/or vote for other lawmakers who seem to have your interests in mind.
One surefire way to not earn PSLF is to not try. If you’re working with a qualifying organization, then you’re likely doing many of the right things already! If you have questions about the rest, reach out for help! You can also review the “Most direct path to Public Service Loan Forgiveness (PSLF) for Veterinarians” document in the VIN Foundation WikiDebt resource.
“I was planning to pay based on my income using an income-driven repayment plan like PAYE, REPAYE or IBR, but after seeing so few people get forgiveness, I’m not sure that is the right strategy for me.”
While confusion caused by the recent data on PSLF and the constant calls to eliminate student loan forgiveness is certainly understandable, there are details we need to clarify between Public Service Loan Forgiveness and the forgiveness which occurs under income-driven repayment plans, like ICR, IBR, PAYE, and REPAYE. If you’re unfamiliar with these acronyms, review the WikiDebt income-driven repayment comparison table.
Not all student loan forgiveness is created equal. There are two general types of student loan forgiveness: 1) Tax-Free, and 2) Taxable.
Tax-Free Student Loan Forgiveness:
PSLF is a benefit you apply for and might receive IF you do all of the right things for a period of at least 120 months, or 10 years. In order to be eligible to apply for PSLF, you must have made 120 monthly on-time payments to Federal Direct Loans using an income-driven repayment plan (ICR, IBR, PAYE, REPAYE) or standard 10-year plan, while working full-time as an employee of a federal, state, tribal entity or 501c3 organization. If you’re working towards PSLF or expect to receive PSLF in the future, then submit the PSLF Employment Certification Form at least annually to be sure.
Once you’ve made 120 qualified monthly payments, you’re able to apply for PSLF. If granted, any remaining eligible federal student loan balance will be forgiven tax-free. PSLF is the holy grail of student loan repayment if you can get it! Don’t let the early returns dissuade you from earning PSLF as long as you are meeting all of the requirements. Learn from the mistakes of others and you will be eligible for tax-free forgiveness sooner rather than later.
Taxable Student Loan Forgiveness:
However, there is another type of student loan forgiveness that confuses many borrowers, even though they may be using plans where their monthly payments are based on their taxable income. Income-driven repayment plans have maximum repayment periods. The periods are 20 or 25 years depending on your loans and repayment plan. If you reach the maximum number of payments under an income-driven repayment plan, any remaining balance is forgiven. Let’s call this income-driven repayment forgiveness (IDRF).
The two major differences between IDRF and PSLF.
- IDRF is treated as taxable income
- IDRF does not require an application for forgiveness, rather it is automatically granted once you reach the maximum number of payments while using income-driven repayment.
As noted in the Code of Federal Regulations for income-driven repayment (§682.221 and §685.209), “The loan holder determines when a borrower has met the loan forgiveness requirements … and does not require the borrower to submit a request for loan forgiveness.
No later than six months prior to the anticipated date that the borrower will meet the loan forgiveness requirements, the loan holder must send the borrower a written notice…”
Within 6 months of reaching the maximum repayment periods under income-driven repayment, your loan servicer must tell you that you are nearing student loan forgiveness.
The calendar year in which forgiveness occurs will be important because this forgiven debt will be treated as taxable income. You will report the balance forgiven on your tax return after you receive a 1099-C for the amount canceled (aka forgiven). Your tax liability will depend on your total income and the federal (and any state) income tax rates the year forgiveness occurs. To estimate your student loan forgiveness tax liability, review the Forgiveness Planning Module in the VIN Foundation Student Loan Repayment Simulator and read the WikiDebt section on forgiveness planning.
Student Loan Forgiveness Take-Home Points:
Just because 99% of folks who have applied for PSLF thus far have not received loan forgiveness does not mean you will be denied PSLF. Forgiveness under PSLF is very different from the forgiveness under income-driven repayment plans. Taxable forgiveness does not require an application and will happen when/if you reach the maximum repayment period for income-driven repayment.
For the majority of recent graduate veterinarians who have federal student loans, income-driven repayment is an essential part of a financial wellness plan. Don’t let the early news on PSLF dissuade you from using income-driven repayment. Also, don’t discount working towards PSLF if that matches with your veterinary career aspirations. If you’re not sure how to evaluate your income-driven repayment plan eligibility or compare the various repayment options, try the tools available on the VIN Foundation Student Debt Center.