A tax time bomb could be looming large for students who borrowed money in order to go to school. One way to repay those loans is to use the income-based repayment program. This is when the monthly payments are limited on federal loans based on what you can afford to pay. A formula is used to figure out the income you have in order to determine payment. After roughly 10 or 25 years, the federal government will forgive any remaining balance on the loan.
According to The New York Times, there is a catch that comes with the federal government forgiveness. That catch is that you have to pay income taxes on forgiven debt. For most, finishing school with a debt of six figures comes with a tax bill into five figures. When the bill arrives, it is supposed to be paid in full.
Roughly two million people applied for income-based repayment as of October 31, according to data from the Education Department. Under the terms of the program, close to 1.3 million had low enough income and large enough debt payments to qualify for the repayment options. Right around another 440,000 applications had yet to be approved or denied.
The College Board’s Trends in Student Aid report said that during the 2011-12 school year, 10 million people took out Stafford student loans.
The founder of the Advantage Group in San Diego, Jantz Hoffman, said, “Let’s say your debt has grown to $180,000 over 20 years, and by that point, you’re making $120,000. If $180,000 is being forgiven, then you’re looking at paying taxes on $300,000 in total income in one year. At that point, you’re over the $250,000 income category, my friend.”
No matter who is enrolled in the repayment plan, you might want to consider saving a large sum of money as much as possible in preparation for the tax bill that will eventually arrive in your mailbox one day. That sum of money will need to paid right away and the IRS does not offer a repayment program.