Defusing The Student Loan Forgiveness Tax Bomb

TaxProf Blog:
Following up on my previous post, The 'Tax Bomb' Facing Lawyers Who Enroll In Income-Based Student Loan Repayment Plans:
Steven Chung (Lawyerist), Defusing the Student Loan Forgiveness Tax Bomb:
For those who are struggling to repay their federal student loans, there are alternative repayment plans available.
The programs are known as Income Based Repayment (IBR) and Pay As You Earn (PAYE).
These plans lower borrowers’ monthly student loan payments based on a percentage of their monthly income.
If they stay on these plans for twenty to twenty-five years, then any balances remaining are forgiven.
While these plans sound tempting, there are caveats.
First, these plans are not available for private loans, which includes companies like SoFi. Second, Lawyerist writer Lisa Needham warned that income-based student loan repayment plans are a trap. According to Jacob Gershman’s article in the Wall Street Journal, some will have to get ready for a hefty tax bomb once their federal student loans are forgiven starting in 2032.
The Treasury Department ruled that any federal student loans forgiven under the IBR or PAYE programs are considered taxable cancellation of debt (COD) income and must be reported on the borrower’s income tax return.
However, if the taxpayer can show that he is insolvent, then he can reduce or eliminate COD income depending on the amount of his insolvency.
Forgiven student loan debt is not taxable to those who complete the ten year Public Service Loan Forgiveness program.
This article will explain how the insolvency exception works and provide some strategies to defuse the tax bomb.