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.
Alexander 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.