With all of the recent changes to federal tax law, it is hard to keep up with everything. However, if you are a borrower, make sure you are keeping track of changes in student loan-related legislation. As of January 1, 2018, a new law took effect that makes discharging student loans more manageable for anyone who is eligible.
Trump Administration New Tax Law for Discharged Student Loans
Trump’s new tax law changes tax brackets, deductibles, and a lot more. More notably, for certain student borrowers, it changes the tax exemption status of discharged student loans. As of January 2018, discharged student loan debt is no longer considered income. Any student loan debt that is discharged due to death or total and permanent disability (TPD) is no longer taxable.
Make note that this is not a retroactive law. Anyone awarded TPD student loan discharge during the 2017 tax year will still have to pay taxes come April 2018. The new law covers eligible loans discharged from January 1, 2018 to December 31, 2025. Only loans discharged during this time are tax exempt. The bill expires in 2025, but Congress can renew it if desired.
Why Does this Change Matter?
If you are not familiar with loan discharge, you may not realize how significant this new law is. Part IV of the Trump administration’s new tax law eliminates the biggest hardship for those seeking out loan discharge–the tax burden. It was a burden so large that it actually stopped eligible individuals from seeking loan discharge. Thankfully, that burden is now gone.
The Previous Tax Burden of Total & Permanent Disability Discharge
Under previous legislation, loans discharged due to death or TPD were viewed as income tax by the IRS. This means that individuals had to pay taxes on this money just as they would with their yearly wages. Plus, the higher income status actually disqualified many from receiving means-based government benefits like Medicaid and SSI–benefits designed in part to help individuals with disabilities who cannot work. If someone with the current average student loan debt of $37k had their student loans discharged, they would end up with a tax bill of anywhere between $3,700 to $14,800 depending on their tax bracket.
In the past, opting not to pursue TPD discharge was the wiser financial decision for many. Paying the required taxes was a bigger burden than making monthly payments. In fact, many individuals eligible for TPD loan discharge would choose an income-driven repayment plan instead. These student loan repayment plans could bring their monthly payment down to as little as $0 with forgiveness after 25 years. Unfortunately, repayment programs are considered taxable income, but they provide more time for borrowers to prepare for the tax bill.
Benefits of the New Tax Law for Total & Permanent Disability Discharge
There are many positive implications of the new tax law for recipients of TPD discharge. Aside from it saving people money, it also helps them hold onto their financial security.
- Their reported income will no longer be artificially inflated by the amount they receive in loan discharge. This means that they remain eligible for programs like Medicaid and SSI. It also means that they do not have to choose between discharging their student debt and their health insurance or monthly living stipend. They can have it all.
- They can hold onto their savings and use the money for things like medical bills and experience some financial security during their time of hardship and limited income.
- They no longer have to prolong loan forgiveness. With the new law, everyone who is eligible can afford to pursue total discharge. They will not need to choose an income-driven repayment plan, which may require monthly payments and/or filing annual paperwork to report their yearly income.
- With the money saved from the new tax bill, individuals have more flexibility to pay off any remaining student loan debt they have from private lenders.
Can Private Loans be Discharged?
The new tax law applies to both federal and private student loans discharged due to total and permanent disability. The legislation defines a private education loan as a loan that:
- Was not made, insured, or guaranteed under title IV of the Higher Education Act of 1965; and
- Was issued to cover postsecondary educational expenses; and
- Does not include an extension of credit, mortgage transactions, or loans taken out against your property
Unfortunately, the majority of private lenders do not offer loan discharge due to permanent disability. However, if you borrowed from Sallie Mae, Wells Fargo, Discover, or New York Higher Education Services Corp., you may be in luck. Only those four private student loan providers discharge debt in cases of total and permanent disability.
You will need to contact your lender directly for information regarding student loan disability discharge. Their definition of “total and permanent disability” may differ from the federal government’s. Even if your lender is not listed above, they might offer other options like reduced monthly payments.
Is Loan Forgiveness Viewed as Taxable Income?
The new tax law did not affect the tax status of student loan forgiveness programs. The Public Service Loan Forgiveness, Teacher Loan Forgiveness, Law School Loan Repayment, and National Health Service Corps Loan Repayment programs will all remain tax-exempt. After completing the required years of service, enrolled participants will have all eligible loans forgiven (canceled) and will not have to pay any taxes on that money.
Although similar in some ways, loan discharge and loan forgiveness are quite different. Loan discharge only applies to two circumstances: when the borrower dies and when the borrower has a total and permanent disability. Loan forgiveness programs erase eligible federal student debt after a borrower fills a public service job for a set number of years.
Remember that loan cancellation for those enrolled in income-driven repayment plans that are not participating in a program above still have to pay taxes on the amount forgiven. The new law did not address this.
Is Total & Permanent Disability Discharge Right For You?
Without the tax burden, there is no reason not to apply for TPD discharge. If you think you may be eligible for student loan discharge due to total and permanent disability, visit the Federal Student Aid’s website. You do not need a student loan lawyer to apply for this type of discharge. There, you can find out more information and fill out an application. Note that you will need proof and documentation of total and permanent disability. This can be provided by your doctor, the Social Security Administration, or the U.S. Department of Veteran’s Affairs.
Student loans are a hot-button issue for borrowers and politicians. Expect to see more changes under the Trump Administration regarding student loan forgiveness programs and related matters.