Cancellation of Student Loans Tax Liability

Some loan forgiveness programs are taxable and some are not. Under current law, the amount forgiven generally represents taxable income for income tax purposes in the year it is written off.


Cancellation of Student Loans Tax Liability

There are, however, a few exceptions. Generally, student loan forgiveness is excluded from income if the forgiveness is contingent upon the student working for a specific number of years in certain professions.


How the cancellation of your student loan will affect your tax liability?

The first important consideration is that the cancelation of a debt will be considered taxable income by the IRS. Lenders will typically report this amount on a 1099-C. This means that you will generally have income if your student loan is canceled.

However, in regards to student loans, there are certain exceptions to the cancellation of debt tax rules that are favorable for students who obtain loan forgiveness. The bottom line is, that if your student loan qualifies for the exception described below, you won’t have income from the cancellation.


Debt Cancellation Due to Government Service

Many government student loans contain a provision that all or part of the debt will be canceled if the student works for a time period in a certain profession. These are usually government incentives to get skilled employees to certain rural or underserved areas.

If cancellation of all or part of your student loan is contingent on your fulfilling this type of service requirement, the taxpayer will not have any income if any part of the loan is canceled because you performed the required services. The income will simply be excluded from income due to the cancellation of student loan debt and the taxpayer receives a very favorable tax benefit. However, before wishing to take advantage of this benefit, it will be a good idea for the student to check if their student loans will qualify for this type of debt forgiveness.

Qualifying student loans may be made by government entities, by tax-exempt public benefit corporations, or by tax-exempt educational institutions out of funds the institution received from a government entity or tax-exempt public benefit corporation. Generally, the loan must be made from government funds to qualify for this exceptions.


Qualifying Loans for Cancellation of Student Debt

Loans made by tax-exempt educational institutions out of private, nongovernment funds also qualify, but only if the loan imposes a public service requirement. Generally, the loan must of been made under a program designed to encourage students to serve in occupations or areas with unmet needs, and the services provided by the student (or former student) must be for or under the direction of a governmental unit or a tax-exempt organization.

Lastly, Qualifying student loans also include loans made to refinance another qualifying student loan. Thus, you won’t have income from the cancellation of a loan made by a tax-exempt organization, where the proceeds of the loan are used to refinance an outstanding student loan. But this only applies if you wouldn’t have income from the cancellation of the refinanced student loan. Also, the refinancing loan must be made under a program of the refinancing organization that requires the student to fulfill a public service requirement.


Other Loan Forgiveness Information and Debt Programs

Student loan payers must be careful though. They will have income if a student loan (original or refinancing) is canceled because of services performed for an educational institution. This means that you can’t be employed by the lender organization. This could happen when student works for their original educational institution as part of the debt forgiveness program.

Remember, if you do not meet all requirements of the loan forgiveness program, there might be income from the loans.  You will have income from the cancellation of your student loan if you don’t fulfill your public service obligation, or if the service obligation doesn’t qualify for the exclusion.

Be sure to check the cancellation of student loans meets these requirements before relying on a certain figure for your tax liability.