Over the last few years, we have seen a massive increase in temporary government programs to help student loan borrowers.
Some of these programs were created to provide financial relief during the Covid-19 pandemic. Others came into existence under temporary authority from Congress or to provide a one-time fix caused by servicer errors and borrower confusion.
Problems arise when borrowers are told one thing but see rules posted that say the exact opposite.
The goal of this article is to clear up potential confusion caused by temporary fixes to federal student loan rules.
Taxes on Federal Student Loan Forgiveness
It isn’t easy to keep track of the tax rules on student loan forgiveness. Recent temporary changes only make things more confusing.
Public Service Loan Forgiveness (PSLF) is tax-free. This rule is written into the statute. If you qualify for PSLF, you won’t have to pay any tax on the forgiven debt.
If you qualify for forgiveness after 20 or 25 years under an IDR plan, the rules are less clear. The general rule was that this form of forgiveness was taxed. Borrowers often called it the student loan forgiveness tax bomb.
Fortunately for many borrowers, the tax bomb was temporarily suspended through recent legislation. If your loans are forgiven under IDR forgiveness before 2026, there will not be a tax bill. If you reach forgiveness after January 1, 2026, the current rules call for you to get taxed.
Sherpa Thought: Planning a repayment strategy when the rules are uncertain isn’t ideal. I think the tax on IDR forgiveness will eventually get permanently erased. However, as a borrower working towards IDR forgiveness, I have a backup plan to get ready for the tax.
Limited Waiver on PSLF
When borrowers first became eligible to have their loans erased via PSLF, the initial rejection rate was 99%.
Even though the numbers improved slightly, it was clear that many deserving public servants had applications rejected. Problems often centered around ineligible repayment plans and ineligible federal loans.
To fix this problem, the Department of Education created the Limited Waiver on PSLF. This allowed borrowers to correct previous PSLF mistakes and update their progress.
Sadly, the Limited Waiver program ended on October 31, 2022. Borrowers with PSLF eligibility issues now have to use the less generous Temporary Expanded PSLF. The TEPSLF program will remain active until the funding runs out.
IDR Count Update
The Department of Education will be updating each borrowers progress toward the 20-25 years required for IDR forgiveness.
All previous periods of repayment will now count as progress for IDR forgiveness. Additionally, some deferments and forbearances will also count. Borrowers with FFEL loans will need to apply to consolidate into a federal direct loan by December 31, 2023, to take advantage of this program.
Notably, this updated count will also help borrowers who are pursuing PSLF. For FFEL borrowers, the IDR count update almost functions as an extension on the limited waiver program.
IDR Consolidation and Restarting the Student Loan Forgiveness Clock
The basic rule is that if you consolidate your federal student loans, your progress towards IDR forgiveness restarts at zero. While consolidation is an important move for some borrowers, this wrinkle makes the decision to consolidate somewhat more complicated.
However, there is a temporary rule in place that will allow borrowers to consolidate without losing their progress toward IDR forgiveness. For some borrowers, consolidating now is a great way to keep previous progress and get credit for some prior deferments and forbearances.
The deadline for borrowers to take advantage of the one-time IDR count update is December 31, 2023.
It is also worth noting that some recently announced proposed student loan changes would allow borrowers to consolidate without losing progress towards forgiveness. However, at this point, nothing has been finalized.
Changes to Bankruptcy Rules
For many years, getting student loans discharged in bankruptcy was nearly impossible. Most bankruptcy attorneys wouldn’t even take the case.
Last fall, the Biden administration quietly updated the guidance for Department of Justice attorneys in bankruptcy cases. These changes make it significantly easier for borrowers to erase student debt in bankruptcy. The hope is that most bankruptcy attorneys will now be able to help student loan borrowers.
The changes do not alter any statutes or case law, so a new presidential administration could mean the borrower-friendly bankruptcy rules get erased.
Federal Student Loan Payment and Interest Freeze
Sadly, the Covid-19 relief will eventually come to an end. At that point, borrowers will have to resume making payments, and loans will resume accruing interest.
The date of the restart will depend upon when the Supreme Court rules on Biden’s one-time forgiveness plan.
$0 Per Month Student Loan Payments
Many borrowers get confused when IDR Payments result in a $0 per month payment. This “payment” counts towards the various forgiveness programs. Even though it feels like a deferment or a forbearance, it is a much better alternative.
$0 per month payments are permanent because borrowers can qualify each year until their debt is forgiven. However, it is temporary, because you have to certify your income each year. If you start earning more money, the $0 payments may come to an end.
What Student Loan Programs are Permanent?
Many borrowers fear that “permanent” programs like IDR repayment or PSLF are not actually permanent.
While it is true that Congress could theoretically end these IDR or PSLF, it isn’t a likely event. These changes would be highly unpopular and controversial. Such a bill is unlikely to get through Congress and be signed off by the President. Even if it did, borrowers have protections in the contract they signed with the government.
The student loan contract is called the Master Promissory Note. It spells out the rules for the student loan, repayment plan terms including IDR, and Public Service Loan Forgiveness.
The multiple layers of protection make recent proposals to end PSLF less threatening to borrowers.