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Unable to Pay Your Student Loans? It Won't Affect Your Taxes Yet

On the second anniversary of the student loan payment pause, We, The 45M, project a message on the outside of the U.S. Department of Education celebrating the pause and asking Education Secretary Cardona to cancel student debt in Washington, D.C. on March 14, 2022 Credit - Paul Morigi—Getty Images/ We The 45 Million

Azereth Deason owes more than $18,000 in undergraduate loans, but mounting debt was the least of her worries during the pandemic.

“Those three years just felt so short,” Deason says, referencing the three-year student loan payment pause put in place during the pandemic. “I have rent to pay, I have bills to pay, I have health[care], so as wrong as it sounds, it wasn't really in my priorities as far as my worries in life.”

The 24-year-old, who lives in New York City, is one of nearly 9 million borrowers who have not made a student loan payment since they resumed in October 2023, and while experts warn that financial consequences could come later, loan repayment or discharge won’t affect taxes through 2025.

Thanks to a provision in the 2021 American Rescue Plan, borrowers who are eligible for student loan forgiveness won't be taxed on the forgiven amount through the end of 2025. Without that rule, if a lender discharges a debt, the forgiven amount typically counts as taxable income.

Experts said they understand why many borrowers are struggling to pay student loans, echoing the Education Department’s own warnings about possible high levels of student loan delinquency and default without student loan relief.

“There are millions of people who have been trying to navigate what is a very financially traumatic return to student loan payments after more than three years of no bills and no interest,” Mike Pierce, executive director of the Student Borrower Protection Center says. “This was a system that wasn't built to restart loan payments for more than 20 million people on the same day.”

What could happen if a borrower doesn’t pay?

Borrowers should generally avoid putting their loans on default, or being 270 days past payment, to avoid seeing their tax refund garnished. However, the Biden Administration’s 12-month on-ramp to repayment program currently prevents borrowers from facing a penalty if they don’t make loan payments through Sep. 30 2024. That means any borrower who misses a payment will not be placed in default or reported to a credit bureau, so they won’t have to worry about money from their tax refund being revoked by the Treasury Department.

Pierce says that any borrowers who were not in default before the pandemic would not be affected by tax offset, or a reduction in their tax refund, until after 2025.

But after that period, Alison Flores, manager at the Tax Institute at H&R Block, warns that borrowers could have an offset request put on their account if they go into default, which could reduce or deduct their entire tax refund amount.

“Instead of having the Treasury issue that [tax] refund right away, it'll go through an offset process and any amount of past due student loan may be essentially deducted from their tax refund,” Flores says.

Flores adds that not paying off student loans could impact a borrowers’ credit score, and eventual eligibility for broader loan forgiveness. “A lot of repayment programs that people are in would require you to make so many monthly payments on-time and then they may discharge the remaining debt eventually at the end of that program,” Flores says. “If they start skipping now, they could lose that eligibility.”

Why borrowers aren’t paying

A December report by the Department of Education found that 40% of student loan borrowers had not made a payment by mid-November 2023, just weeks after repayment began. Research from the Philly Fed shows that nearly a quarter of borrowers either expected to struggle to make payments intermittently, or make payments at all once student loan payments restarted after the pandemic.

Of those who have failed to make any payment since October 2023, 63% said they could not afford to do so at all. More than half of those who only made a partial payment expressed a similar sentiment.

Deason says she works a 9-to-5 and has a side gig at a local arena, but still struggles to make ends meet. She is currently enrolled in a payment plan that she says would make her bill the lowest possible, which is still about $250 a month.

“If I started making over 60,000 a year, sure, I would consider [making payments] but right now I'm making under that even with the two jobs,” she says. Deason was eligible for $10,000 in student loan forgiveness through President Biden’s loan forgiveness plan that could have seen student loan debt canceled for some 42 million Americans, but never saw relief after the Supreme Court struck it down in July.

Others borrowers express similar financial strain, but add that they felt emboldened by conversations with their peers to not pay. “Hearing a lot of my friends expressing similar sentiments [that]...they didn't really know how they were going to start making payments really made me realize that I wasn't the only one,” Izabella Nuñes, a 24-year-old based in New York City, says.

Nuñes is recently unemployed, and says she has fears of ruining both her credit and that of her mother, but remains hopeful that the Biden Administration, or Congress, will eventually have to tackle the issue head on because so many people are unable to make payments.

“They're going to have to address it at some point, she says. “Nine million people didn't pay.”

Pierce points out that millions of other borrowers have not been paying off their loans because of mismanagement and other poor practices by their loan servicers. The Education Department found that at least 3.25 million borrowers did not receive a timely billing statement, according to press releases published in October 2023 and Jan. 5.

The mass influx of borrowers returning to payments has caused long hold times since last fall, and serious delays in processing income-driven repayment plan applications, which are the most affordable option for most borrowers. A Consumer Financial Protection Bureau report shows that more than 1.25 million payment plan applications were still pending in late October, when payments had already resumed.

What about borrowers who are paying off their loans?

Borrowers who are able to make payments towards their loans can take advantage of a federal tax deduction of up to $2,500 on their tax return. To cash in this benefit, borrowers should make sure they receive a 1098-E, or a student loan interest statement, from their lender.

The benefit applies to all loans, though there are income restrictions. Single borrowers have to make $75,000 or less to claim the full deduction, or can have an income up to $90,000 to earn partial credit. Those who are married and filing jointly cannot claim a deduction if their modified adjusted gross income is $185,000 or more.

Flores says that borrowers should have already received a copy of the form in the mail. However, many borrowers should also be able to access it through their online student loan portal, or should check their emails to see if they received information about this tax deduction.

Contact us at letters@time.com.