Cancellation of Student Loans

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 if your student loan is canceled. But if your student loan qualifies for the exception described below, you won't have income from the cancellation.

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

Qualifying student loans may be made by government entities (e.g., the U.S., or a state), by tax-exempt public benefit corporations, or by tax-exempt educational institutions out of funds the institution received from a government entity or tax-exempt public benefit corporation. That is, loans made with government funds may qualify.

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.

The Public Service Loan Forgiveness Program is a federal program that forgives the remaining balance on your federal direct loans if you meet certain requirements. You must work full-time for a qualifying employer and make 120 qualifying monthly loan payments while doing so. Therefore, it is possible to have a loan forgiven after as little as 10 years. Qualifying employers include government organizations, 501(c)(3) nonprofit organizations, and other types of nonprofit organizations if their primary purpose is to provide certain types of qualifying public services.  You can find additional information regarding this program and all of its requirements at https://teststudentaid2.ed.gov/testise2/repay-loans/forgiveness-cancellation/public-service.

With the change in federal administration at the beginning of 2017, it is important to be aware that changes to the Public Service Loan Forgiveness Program may be possible in the future. The most recent proposed White House budget would end the program for loans issued on or after July 1, 2018, unless the loan was provided to help the student finish their current course of study. The budget also proposed changes to an income-based repayment plan, which includes forgiving student loan debt sooner, but at the cost of higher monthly payments. Also, income-based loan forgiveness is taxable to the borrower. Any proposed changes must be approved by Congress.

Many states also have student loan forgiveness programs. These may be general or for specific fields of employment, such as teaching or law. You can find additional information regarding student loan forgiveness programs for a specific state at http://thecollegeinvestor.com/student-loan-forgiveness-programs-by-state/.

It is important to remember that the exception described above is tied to a public service requirement. You will have income from the cancellation of your student loan if you don't fulfill your public service obligation, or if the service obligation doesn't qualify for the exclusion.

Please contact us if you have any questions or would like more information.

Tax Deductions for College Expenses

As a parent of a college-age child, your goal is to pay for current or imminent college bills. We would like to address this concern by suggesting several approaches that seek to take maximum advantage of tax benefits to minimize your expenses. (Please note that the following suggestions are strictly related to tax benefits. You may have non-tax-related concerns that make the suggestions inappropriate.)

Tuition tax credits. You can take an American Opportunity tax credit (AOTC) of up to $2,500 per student for the first four years of college-a 100% credit for the first $2,000 in tuition, fees, and books, and a 25% credit for the second $2,000. You can take a Lifetime Learning credit of up to $2,000 per family for every additional year of college or graduate school-a 20% credit for up to $10,000 in tuition and fees.

Both credits are phased out for higher-income taxpayers. The American Opportunity tax credit is phased out for couples with income between $160,000 and $180,000, and for singles with income between $80,000 and $90,000. The Lifetime Learning credit is phased out (for 2017) for couples with income between $112,000 and $132,000, and for singles with income between $56,000 and $66,000. The phase-out range for the Lifetime Learning credit is adjusted annually for inflation.

Only one credit can be claimed for the same student in any given year.

Statement from institution required before tuition credits or qualified tuition deduction can be claimed. To claim the tuition tax credits, a taxpayer must receive a Form 1098-T payee statement from the educational institution. For purposes of this requirement, if a person the taxpayer claims as a dependent receives the Form 1098-T, the statement is treated as received by the taxpayer.

Scholarships. Scholarships are exempt from income tax, if certain conditions are satisfied. The most important are that the scholarship must not be compensation for services, and it must be used for tuition, fees, books, supplies, and similar items (and not for room and board).  Scholarships used for room and board would be taxable to the student.

Although a scholarship is tax-free, it will reduce the amount of expenses that may be taken into account in computing the American Opportunity and Lifetime Learning credits, above, and may therefore reduce or eliminate those credits.

Employer educational assistance programs. If your employer pays your child's college expenses, the payment is a fringe benefit to you, and is taxable to you as compensation, unless the payment is part of a scholarship program that's "outside of the pattern of employment." Then the payment will be treated as a scholarship (if the other requirements for scholarships are satisfied).

Tuition reduction plans for employees of educational institutions. Tax-exempt educational institutions sometimes provide tuition reductions for their employees' children who attend that educational institution, or cash tuition payments for children who attend other educational institutions. If certain requirements are satisfied, these tuition reductions are exempt from income tax.

College expense payments by grandparents and others. If someone other than you pays your child's college expenses, the person making the payments is generally subject to the gift tax, to the extent the payments and other gifts to the child by that person exceed the regular annual (per donee) gift tax exclusion of $14,000 for 2017. Married donors who consent to split gifts may exclude gifts of up to $28,000 for 2017.

However, if the other person pays your child's school tuition directly to an educational institution, there's an unlimited exclusion from the gift tax for the payment. The relationship between the person paying the tuition and the person on whose behalf the payments are made is irrelevant.

The unlimited gift tax exclusion applies only to direct tuition costs. There's no exclusion (beyond the normal annual exclusion) for dormitory fees, board, books, supplies, etc. Prepaid tuition payments may qualify for the unlimited gift tax exclusion under certain circumstances.

Student loans. You can deduct interest on qualifying loans used to pay for college education expenses. The maximum deduction is $2,500. However, the deduction phases out for taxpayers who are married filing jointly with AGI between $135,000 and $165,000 (between $65,000 and $80,000 for single filers).

Bank loans. In order to take the student loan interest deduction, the loan must be a “qualifying” student loan.  Therefore, interest on non-qualifying bank student loans will be nondeductible. However, if you use a home equity loan, the interest is deductible for regular income tax purposes (although not for alternative minimum tax purposes). Interest on home equity debt would be reported on Schedule A.

Borrowing against retirement plan accounts. Many company retirement plans permit participants to borrow cash. This option may be an attractive alternative to a bank loan, especially if your other debt burden is high. However, the loan must carry an interest rate equal to the prevailing commercial rate for similar loans, and, unless you qualify for the deduction for education loan interest (described above), there's no deduction for the personal interest paid. Moreover, unless strict requirements are satisfied, a loan against a retirement account is treated as a premature distribution (withdrawal) that's subject to regular income tax and an additional penalty tax.

Withdrawals from retirement plan accounts. IRAs and qualified retirement plans represent the largest cash resource of many taxpayers. You can pull money out of your IRA (including a Roth IRA) at any time to pay college costs without incurring the 10% early withdrawal penalty that usually applies to withdrawals from an IRA before age 59½. However, the distributions are subject to tax under the usual rules for IRA distributions.

Not all of the above breaks may be used in the same year, and use of some of them reduces the amounts that qualify for other breaks. So it takes planning to determine which should be used in any given situation. If you would like to discuss one or more of the above payment possibilities, or any other alternatives, in more detail, please contact us.