You’ve finally gotten those old federal student loans discharged and now have some breathing room to pay down bills, perhaps put aside some money for retirement or begin building a college fund for your kids. Before you start spending your now free cash though, have you received your new tax bill? If not, there’s a Form 1099-C somewhere in the system waiting for you.
Improving But Miles To Go
Previously, the Education Department had what could only be called a broken system for loan holders trying to discharge their debt; it was particularly onerous for disabled borrowers. The Department has made improvements since then and more are currently working their way through Congress. It’s excellent timing for needy families. In 2008, the number of loans discharged because of what can be determined as a permanent disability was 15,000. This increased by a factor of four to 61,600 in 2011. That number nearly doubled to over 115,700 just last year.
Many people are now able to legitimately discharge their loans, but are unprepared for what happens next. Anyone considering loan discharge has to know that these amounts are still considered taxable income for the year the process has been completed. According to a story in the New York Times, one family found themselves hit with a $59,000 tax bill almost immediately after clearing an over $150,000 student loan debt that covered three college degrees. In this case, it was a disability discharge that stopped a man from working further to continue paying off loans he had been in good standing with for many years.
The Taxman Does Not Forgive But He Does Reduce
The IRS cannot forgive the full amount under current law, but the agency will reduce the tax burden for borrowers who can prove that they are still being crushed by debt, even if it is a much smaller amount compared to the original student loan. However, the formula for calculating disability tax relief is probably more difficult than getting student loans discharged for disability. As Mark Kantrowitz, publisher of Edvisors put it, “The government gives with one hand, while taking back with the other.”
Fortunately for the borrower, this process isn’t immediate. First, the IRS will send out a bill. A fast response to this is the best one. If the person ignores it, hoping to put it off until their economic situation improves, all they are doing is ensuring a difficult time later. After one or two more notices, a final bill will be sent out demanding payment. This states the amount owed, that the recipient has 30 days to comply and their right to file an appeal.
For people who can’t pay the bill at once, there are options. If the tax bill is less than $50,000, a former loan holder can file a Form 9465 or apply online to begin a monthly payment agreement. For a bill $50,000 or higher, filing the Form 9465 is the only option to apply for a monthly plan. If the person can pay a large percentage of the loan at once, then he may be able to convince the IRS to accept this amount as an “offer in compromise”.
If a former loan holder can prove that her monthly income is exhausted by basic living expenses, then the IRS can declare that the debt is “currently not collectible” and will stop the collection process until the person’s financial situation changes. Details on these and other options can be reviewed at the IRS website. To take full advantage of each option or to file an appeal, anyone should respond immediately to that first letter.
Income Based Repayment May Be A Better Solution
An option that may benefit you more than the disability discharge, is to apply for an income-based repayment plan. If you are legitimately disabled and would qualify for the disability discharge, then you would also very likely qualify for an income based payment of $0.00 per month. This payment of $0.00 would last indefinitely so long as you are unemployed with a minimal adjusted gross income on your tax returns. After 30 years of making zero payments, your loan would be discharged and you would still have a tax bill, but that bill would not arrive until after the thirty years is complete.
If the cost of carrying these loans has created a burden on your family, discharging them is a viable option despite the eventual tax bill. Understanding the process and the financial consequences of using this method is the key to making it a success. Please contact us here at for the best advice available and to determine if this is a good option for you.
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