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Student Loan Forgiveness Programs Have Their Downsides

Student Loan News

Student Loan Forgiveness Programs Have Their Downsides

Student Loan Forgiveness programs sound great on paper, but in reality some programs leave borrowers with a crippling tax debt.

debtAlexander Holt, a tax analyst broke it down for us this way.
“Take a person who started with $20,000 in debt and had a $20,000 salary in her first year out of college with a 2 percent raise every year. She would have about $44,000 ($30,000 in today’s dollars) forgiven after 20 years. Having never paid more than $10 dollars a month, she would owe the IRS at least $4,000 in today’s dollars in additional taxes that year, which would quadruple her income-tax payment (not including extra state taxes she may owe as well). Overall, that year her federal tax payment would be around 30 percent of her actual, near-poverty-level income.”

So while student loan forgiveness may be a sweet deal for borrowers, who have collectively accumulated more than $1.3 trillion in debt. The downside: a potentially big tax bill down the road.

The federal government currently offers two types of loan forgiveness for student debt: public service loan forgiveness and loan forgiveness provided by income-based repayment plans, the latter of which requires two decades or more of loan repayment.

The public service route is tax-free while debt canceled by income-based repayment plans is taxed. That potential tax liability could be crippling to lower-income borrowers.

So while consolidation offers a lower payment and lower interest rates, student loan forgiveness programs convert student loans into tax debt for qualifying students but this tax debt can be up to 40% of a persons income spread out over a number of years.

To some that makes the debt even more of a burden than it was previously.

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