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What If Someone Else Pays Off Your Student Loans?

3 min read

3 min read

Editor’s Note: Congratulations on graduating college! I bet you are really excited to start paying down those student loans. No? Well, let’s daydream for a minute that the loans are magically paid off. It happens! But there may be tax consequences to paying off student loans.

There are a few situations in which someone else may pay your student loans off for you.

But whether the payments were made by a generous friend, family member, nonprofit debt relief program or otherwise, someone may have to pay taxes on the amount of debt paid.

Here are a few situations that are becoming more and more common.

1. What if Great Aunt Mary pays off your student loan as a graduation gift? What are the tax implications?

Answer: If a friend or family member pays your student loans off, it is probably a non-taxable gift to you.

However, your friend or family member may be responsible for filing gift tax returns and for paying any applicable gift tax on the payment. Generally, when a gift is made, the person who makes the gift pays the gift tax rather than the gift recipient. There are annual and lifetime exclusions on gift amounts and other planning strategies to minimize the gift tax. The good news: you don’t need to do anything or pay any additional tax.

2. What happens if your employer pays off the balance of your student loan?

Answer: When an employer pays your student loan balance or makes payments on your behalf, it’s considered compensation. The payments will be included in your Form W-2 wages and are subject to payroll taxes.

3. What if you entered a profession with a loan repayment assistance program and the loan gets paid off?

Answer: There are programs that forgive student loans when an individual works in a certain field for a specified amount of time. This may include doctors, teachers or lawyers who work for tax-exempt organizations, municipal hospitals or for state or county governments. In return for services, these programs forgive debt rather than pay the loans for the individual.

Loans that are forgiven under these debt forgiveness programs are not included in the individual’s gross income, so the amount forgiven will not be taxable.

4. What if a nonprofit debt relief organization pays the student loans off?

Answer: This is a rather new situation and the IRS has not issued guidance on it yet. However, it will likely be treated as a nontaxable gift where:

  • The organization is tax-exempt based on IRS requirements, and
  • The relief is only available for individuals who are in such a financial predicament to justify the assistance under the organization’s tax-exempt purpose.

Though not legal precedent, this is the interpretation organizations such as Rolling Jubilee have taken.

One problem that may arise is that payments could be considered compensation for services the individual provided to that organization. The individual may want to give back to the organization by volunteering and then the IRS may decide that it looks like payment for those services. If that happens, the amount would be included in the individual’s gross income and would be taxable.

Since these arrangements are so new, we don’t yet know how the IRS will respond, but we will be keeping an eye out.

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