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

In general, if a loan or other debt you owe is canceled, you must report the cancellation as income. This means that you will generally have income that you must pay taxes on if your student loan is canceled.

However, if your student loan qualifies for one of the exceptions that the tax law provides, you won’t have income from the cancellation.

Student Loan Cancellation Due to Public Service Work

Many student loans contain a provision that all or part of the debt will be canceled if the student works for a certain period of time in certain professions for any of a broad class of employers (e.g., as a doctor for a public hospital in a rural area).

If cancellation of all or part of your student loan is contingent on your fulfilling this type of service requirement, you won’t have income if any part of the loan is canceled because you performed the required services.

For example, if the terms of a $100,000 loan under a medical educational loan program provide that one-fifth of the loan ($20,000) will be canceled each year the student practices medicine in a qualifying state hospital, the student won’t have to report the $20,000 that’s canceled each year because he or she performs those services.

Qualifying Criteria for Student Loan Cancellation

Student loans that qualify for this exception are loans that are made to a student to help him or her attend a qualified tax-exempt educational institution.

Qualifying student loans may be made by:

  • Government entities (e.g., the U.S., or a state)
  • Tax-exempt public benefit corporations
  • Tax-exempt educational institutions with funds the institution received from a government entity or tax-exempt public benefit corporation

Loans made by tax-exempt educational institutions out of private, nongovernment funds also qualify, but only if the loan imposes a public service requirement.

The institution must have made the loan 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.

Cancelling Student Loans to Refinance Another Student Loan

Qualifying student loans also include loans made to refinance another qualifying student loan.

You won’t have income from the cancellation of a loan made by a tax-exempt organization when:

  • The proceeds of the loan are used to refinance an outstanding student loan
  • You won’t have income from the cancellation of the refinanced student loan
  • The refinancing loan must be made under a program of the refinancing organization that requires the student to fulfill a public service requirement

Exceptions to Public Service Requirement Cancellations

However, you will have income if your student loan (original or refinanced) is cancelled with the following situations:

  1. Services performed for an educational institution where you’re employed by the lender organization.
  2. You don’t fulfill your public service obligation, or if the service obligation doesn’t qualify for the exclusion (if, for example, the loan specifies a geographic area for the public service).
  3. For discharges after 2017 and before 2026, an individual’s gross income doesn’t include any amount from the discharge of a student loan, where the discharge was either made under certain federal statutes, or was otherwise discharged on account of the death or total and permanent disability of the student.

More Information

If you need help, reach out to us at 314-961-1600 or schedule directly here to discuss your situation.

David Smith helps businesses and individuals develop smart business practices for tax and accounting advantages as the president of Smith Patrick CPAs. He serves on MOCPA’s Legislative Policy Task Force and MOCPA’s Firm Leadership Committee. Reach him at 314-961-1600 or schedule directly here.

About Smith Patrick CPA

Smith Patrick CPA is a St. Louis-based, family-owned CPA firm dedicated to providing personal guidance on taxes, investment advising and financial services to small businesses and financially active individuals. For over 30 years, our firm has focused on providing excellent service to businesses, non-profits, individuals and government agencies in St. Louis and the surrounding areas. Investment Advisory Services are offered through Wealth Management, LLC, a Registered Investment Advisor.