Student Loan Forgiveness: Taxable or Tax-Free?
Paying back a veterinary school student debt load can be extremely stressful and confusing. Analyzing the various federal repayment options and programs and choosing the best for your situation is challenging. Spending nearly the last ten years helping to educate veterinary students, veterinarians, and those who work with them navigate their student loans and repayment options, I’ve seen student loan forgiveness cause significant confusion.
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 recently passed the ten-year threshold where people can have their student loans forgiven tax-free under PSLF. The early returns were not encouraging. Of the 29,000 folks who initially applied for PSLF, only 96 were granted 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 to me. Knowing whether or not you were making qualifying PSLF payments was nearly impossible in the early years of the provision. I thought the number granted would be even lower, hovering just above zero. I was not too far off.
However, the reaction to the initial PSLF numbers by current borrowers has been surprising to me.
Here is a common concern I hear expressed by veterinarians and veterinary students after learning about the difficulties of people receiving PSLF:
“I was planning to pay based on my income after I graduate, but after seeing so few people get forgiveness, I’m not sure that is the right strategy for me.”
While I can certainly understand the confusion caused by the recent data on PSLF, 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.
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.
Student Loan Forgiveness Take-Home Points:
Just because fewer than 1% of folks who initially applied for PSLF did not receive loan forgiveness does not mean you will not receive PSLF. Forgiveness under PSLF is very different from the forgiveness under income-driven repayment. IDRF 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.