Dear Liz: You recently wrote about student loan forgiveness. After 15 years as a public defender, my wife was diagnosed with multiple sclerosis and could no longer pursue her career as a lawyer. She applied for forgiveness of the federal student loans she used to attend law school. About three years later, the loans were forgiven. The caveat is that she was required to pay income taxes based on the balance that was erased. The taxes amounted to $63,000. Getting the loan forgiven was easy compared with coughing up the money for the IRS. I thought this should be mentioned.
Answer: The IRS generally considers forgiven or canceled debt as income to the borrower. There are several exceptions, however.
Borrowers don’t have to pay income taxes on student loans forgiven through programs that require them to work for a specific number of years in a certain profession. So public service loan forgiveness, law school repayment assistance, teacher loan forgiveness and the National Health Service Corps’ loan repayment program won’t trigger taxes. Forgiven debt also may be excluded from income if the borrower was insolvent at the time.
Student loan discharges for death, disability, closed schools, false certification and unpaid refunds typically are considered taxable income, however. Forgiveness of remaining balances under income-based repayment programs after 20 or 25 years of payment is also considered taxable.
The taxes owed will be a percentage of the amount forgiven, based on your tax bracket. If you’re in the 25% federal bracket, for example, you’d pay $25,000 for $100,000 of forgiven debt, plus any state and local income taxes. It’s less than the tab you owed, of course, but as you note it can still be a tough bill to pay.
Dear Liz: Someone recently asked you about whether they were responsible for their mother’s credit card debt, and at the end of your answer you suggested she talk to a bankruptcy attorney. How can you promote that kind of irresponsibility?
Answer: Some people are quite firm in their belief that bankruptcy should never be an option — even for elderly widows on fixed incomes with no hope of ever paying off their debts. But if enough things go wrong in their lives, these anti-bankruptcy folks might find themselves grateful that there’s a legal way out of the debtors’ prison that their lives would become.
Today’s top story: How to prepare your finances for the end of the year. Also in the news: Strategies to prevent holiday shopping binges, why your employer wants you to save for retirement, and what to do as you approach retirement.
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The answer? Roughly half our annual incomes. Each year.
No colleges actually charge the amount we’d theoretically be expected to pay. So our out-of-pocket costs would be somewhat less. But the exercise drives home how important it is to run these numbers, early and often, if you want a college education for your kids that doesn’t bankrupt you, and them.
Because I know how the formulas work, I was able to tweak some numbers to lower our EFC. Moving more money into retirement accounts and using savings to pay down the mortgage helped a lot with the federal formula, and helped some with the institutional formula (which, unlike the federal, counts home equity). We still wouldn’t get any need-based help from most colleges but could get some breaks if our daughter gets into one of the most-expensive elite schools. (The total cost of the average public college is $20,000 to $25,000; $40,000 for privates and $60,000 for elites.)
If we didn’t have a fat college savings account, we likely would steer our daughter toward public schools or privates willing to offer merit scholarships to reduce the total cost. It’s much better to start a college search knowing what you can afford than to have to tell your kid, dream school acceptance letter in her hand, that you can’t send her there. Or worse, that you will–and then never be able to retire.
For more about how financial aid formulas work, read my Reuters column this week: “A guide to figuring out the real cost of college.”
American Express’ “Small Business Saturday” credits are back, and they’re more lucrative this year: a $10 statement credit for purchases of $10 or more at qualifying small businesses on Nov. 29. You can get up to $30 in credits on each registered card.
I signed up three of our Amex cards yesterday when registration opened, which means we’re now eligible for $90 in statement credits. I then checked the list of small businesses in our neighborhood where we can use the credits, and sketched out what I plan to buy where. I’ll get a chunk of my Christmas shopping done, while also picking up supplies I was planning to buy anyway.
Free money is always good, and free money to support the businesses that support our community is even better.
Amex says registration for the cards is limited, so hop to it. You can use the “Amex offers for you” tab in your online Amex account or the ShopSmall.com site. Using “offers for you” tab seems to preclude you from registering more than one card, but it appears you can register additional cards at the ShopSmall site. Make sure to read the offer terms so you understand how the credits work and what type of transactions don’t qualify (such as transactions made with an electronic wallet, through a third party or if the merchant uses a mobile or wireless card reader to process the transaction).
Today’stop story: For a low-cost college education, consider moving to these places. Also in the news: Celebrating your small financial victories, the hype surrounding Black Friday, and why more Americans are having a tough time making ends meet.
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Small victories quickly add up.
5 Black Friday Deals That Aren’t (and 3 That Should Be)
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America’s Top Money Problem: Trying to Make Ends Meet
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Everything You Need to Know About Down Payments
When to take that giant leap.
Dear Liz: My nephew was persuaded by a recruiter to attend a for-profit technical college. Then, once he entered, his “advisors” persuaded him to take many, many classes — at full price — always handing him student loan paperwork to get more loans. Then they persuaded him to change his major, necessitating a whole new round of classes and loans to pay for them.
The problem is my nephew has Klinefelter syndrome, a genetic disorder. He was not diagnosed until he was an adult and therefore was left with a mental age of about 12. This is what made him so gullible. He did graduate but in the six years since has not been able to find work because it is obvious to employers that he is mentally challenged. Now his training is becoming obsolete, making jobs even harder to get. This means there is no way he will ever be able to pay back the thousands of dollars in loans. Klinefelter is listed in the disabilities registers, but because he can function, any kind of aid is really hard to get. Do you have any advice on what to do about the looming debt?
Answer: The questionable tactics of some for-profit colleges have prompted regulatory investigations and lawsuits. That doesn’t mean the debt that affected students accumulated will be easy to erase.
Many for-profit colleges rely heavily on federal student loans for their funding. If your nephew’s loans are federal, he might be able to qualify for a total and permanent disability discharge of his federal loans, said Mark Kantrowitz, publisher of EdVisors, a college resource site.
“He will need a doctor to certify that his disability prevents him from obtaining gainful employment,” Kantrowitz said. “He will also need to earn less than the poverty line annually for the three-year post-discharge monitoring period.”
Kantrowitz has more information about such discharges on his site.
Another option is to consult an attorney, Kantrowitz said. “If he lacked the mental capacity to enter into a contract, he might be able to repudiate the loans,” Kantrowitz said.
Your nephew also may be able to discharge the loans in bankruptcy, Kantrowitz said. Typically student loans can’t be erased this way, but there are exceptions, including one woman in Maryland who was able to erase $340,000 in law school and other education debt after a judge said her Asperger’s syndrome made it impossible for her to hold a job.
“The odds of success are low, but many of the successful discharges involved disabilities, especially when the loan program did not provide for a disability discharge,” Kantrowitz said.
A final possibility, if your nephew has federal student loans, is to sign up for an income-based repayment program. If his adjusted gross income is less than 150% of the poverty line, his required payment would be zero and he would be eligible for the discharge of his debt after 25 years.