How does debt forgiveness work and are you eligible?
Debt forgiveness offers relief, but it won’t fix all of your financial problems.
Contributing Writer at Tally
April 17, 2020
Debt can add up quickly, making it easy to get in over your head. And some debts can nail you unexpectedly, like a tax bill. While there are many options for repaying your debt, there are some cases where paying it in full will put you in a financial bind. In these situations, debt forgiveness may help.
The debt collection process is not only stressful for you — it puts added stress on the creditor too. This is why some creditors prefer to settle your debt for less than you owe instead of going through the drawn-out collections process.
Below, we'll go through the different types of debt forgiveness and how to apply for them. But first, let's take a more in-depth look at what debt forgiveness is and how it works.
What is debt forgiveness?
Also called debt relief or debt cancelation, debt forgiveness is when a creditor or organization clears all or a portion of your debt. In some cases, the creditor will wipe the slate clean, but it’s often a third-party company or even the federal government that manages this.
Debt forgiveness is a compromise, and the benefits come at a cost. Aside from repaying a portion of your debt, you may have to pay a fee and can even get a negative hit to your credit score. Debt forgiveness is available for many types of debt, including student loans, taxes and even credit cards.
Federal student loan debt forgiveness
Student loans likely have some of the most robust loan forgiveness plans, but they are for federal loans only. A private student loan doesn't fall under the same rules. Below are some debt forgiveness options for federal student loans.
Income-driven repayment plans
There are a handful of income-driven repayment plans for federal student loans, and each one has small variations to meet different borrower needs.
Each plan's monthly payment is determined by your discretionary income, which is your annual income minus 100% or 150% of the poverty line for your family and state, as determined by the U.S. Department of Health and Human Services.
These income-driven repayment plans are as follows:
Revised Pay As You Earn (REPAYE)
Pay As You Earn (PAYE)
Income-Based Repayment (IBR)
Income-Contingent Repayment (ICR)
The REPAYE, PAYE and IBR plans use the difference between your family's annual income and 150% of the poverty line to determine your discretionary income. Your loan payment under these three plans is 10% of your discretionary income unless you opt for the IBR and took out your loans before July 1, 2014. In this case, your payments would be 15% of your discretionary income.
For example, if you’re a family of four living in one of the 48 contiguous states with a household income of $50,000 per year, the 2020 poverty line is $26,200 per year. Multiply $26,200 by 150% to get $39,300, then subtract $39,300 from $50,000 to get a discretionary income of $10,700. At 10%, your loan payment would be $1,070, which amounts to $89.16 per month. If you fall under the 15% guideline, the payment would be $1,605, which is $133.75 per month.
Keep in mind, you must resubmit your income and household size each year, so the payment will fluctuate as your income and household size change.
With the ICR plan, your discretionary income is your family's annual income minus 100% of the poverty guidelines. Its payment calculation is also different — it's either 20% of your discretionary income or what you'd pay on a fixed-payment, income-adjusted 12-year repayment plan, whichever is lower.
Using the same household information as above, in an ICR plan you would subtract $26,200 from $50,000 to get $23,800 in discretionary income. Multiply that by 20%, and you get payments of $4,760, which comes out to $396.67 per month. As in the previous example, this payment will change with your income and household size.
Depending on the plan you choose and other variables, the federal government will forgive any remaining balance after 20-25 years.
You can apply for these debt-forgiveness repayment plans online.
Job-based student loan forgiveness
There are two types of job-based student loan forgiveness programs. Like the income-driven forgiveness repayment plans, these plans require you to pay back at least some of the loan.
The most robust plan is the Public Service Loan Forgiveness Plan, which applies to nonpolitical government workers at the state, federal or local level, or anyone working with a Section 501(c)(3) nonprofit organization for at least 30 hours per week while repaying their loans.
After making 120 qualifying loan payments – on time and for the full amount on the bill – the federal government will forgive any remaining balance.
The Teacher Loan Forgiveness Program is a little stricter. It requires a teacher to have at least a bachelor's degree and state certification, and work full-time for five consecutive academic years in a school or education service agency serving low-income students. Teachers can find a list of these low-income schools and agencies online.
The amount of forgiveness also varies after five years of employment as a teacher. Science, math and special education teachers can receive $17,500 in loan forgiveness, while all other teachers receive $5,000 in loan forgiveness.
Private student loan forgiveness
Private student loans don't qualify for the range of repayment and forgiveness plans that federal loans do. Still, you're not necessarily stuck trying to manage a loan you can't afford.
As with any debt, the Consumer Finance Protection Board (CFPB) recommends reaching out to your private student loan servicer and explaining your situation. The company may have a debt forgiveness program available.
If the servicer offers no debt forgiveness plans, the CFPB advises attempting to get a graduated or extended repayment plan to ease the burden. The CFPB even offers a sample letter to send to your loan servicer.
Credit card debt forgiveness
While credit card companies aren't necessarily in the market to help you diminish your debt, there are instances when they can be helpful, namely through debt settlement programs.
To get a debt settlement, you must contact a representative of your credit card provider and tell them you aren't able to repay your debt and would like to discuss a debt settlement. The credit card company will generally offer one of two responses: "Sorry, we don't do debt settlements on current accounts" or "I'll transfer you to a rep who can help with that."
If they say yes to working something out, great. You can speak with the representative and see what they can offer you. However, if they say no (and you have been timely with your credit card payments), you can stop making payments and take a negative mark on your credit to qualify for a settlement. Otherwise, you can find a different path.
If the credit card company isn’t willing to offer a debt settlement, you might think contacting a third-party debt relief company will help. But the CFPB strongly recommends against working with debt settlement companies due to high fees, unfulfillable promises and the fact they’ll likely get the same response you did and direct you to leave your credit cards unpaid.
The big issue with credit card settlements is it generally results in the credit card company leaving two negative marks on your credit. First, the credit card company will likely cancel the account, which negatively impacts your credit score by reducing your credit history length and available credit. Second, the credit card account will show you settled it for less than the full amount owed, which can also harm your credit score.
If you’re unable to make your monthly credit card payments, you can also consider options like the Tally line of credit. Tally's line of credit may offer you a lower-interest line of credit to reduce your monthly payment and help you pay off your debt faster.
You can also try debt consolidation to lower your monthly payments, but this can come with high fees and strict credit score requirements.
Tax debt forgiveness
Many people see Tax Day as the time when they find out how much money the government owes them, but there are plenty of people who are stuck owing the government. In some cases, these owed taxes are unexpected, leaving the person indebted to the IRS.
Much like other federal debts, the IRS offers a forgiveness program to help taxpayers settle their debt without paying the full balance. This program is called the offer in compromise (OIC).
The IRS looks at your ability to pay, income, expenses and asset equity when determining your eligibility for an OIC. If it sees that paying your taxes in full will put you in financial hardship and you meet all other requirements, it will approve an OIC that represents the most the IRS "can expect to collect within a reasonable period of time."
There's a long list of qualifiers that determine eligibility for an OIC, but the IRS online pre-qualifier helps streamline the process. Once you complete the pre-qualifier, you’ll know if you meet all the requirements to apply for the offer in compromise.
If you qualify, you’ll download the Form 656 Booklet and follow the instructions to formally apply. The application process includes filling out forms 656 and 433-A or 433-B (all the required forms are in the Form 656 Booklet) and paying a $186 application fee. You can have the application fee waived if you qualify for a low-income certification, which you can determine on page two of form 656 in the booklet.
Offer in compromise amount
The IRS gives little guidance online as to how much an offer in compromise should be, leading to some confusion. The only requirement the IRS mentions is that the offer must be higher than $0. The forms 433-A and 433-B clear this up with a simple calculation that adds the equity in your assets and your remaining future income (income minus expenses) to determine your OIC amount. If you receive a rejection, you can submit a new offer without repaying the application fee.
Paying the OIC
When paying the offer in compromise, you have two options: a lump sum or payment plan.
In the lump sum plan, you must pay 20% of your OIC amount upfront then pay the remaining balance within five months.
With the payment plan you pay over the course of 6-24 months. If you choose the payment plan, you must include the first payment with your application and continue making the payments while the IRS considers your offer.
Once you complete the payment plan or pay off the lump sum, the IRS will forgive any remaining tax debt balance.
Tax considerations for debt forgiveness
When you have certain debts forgiven, the IRS may view the amount the company or organization forgives as income, which can result in a higher tax bill for you the following year. In the case of tax debt, the IRS doesn’t view the forgiven balance as income. For credit cards and student loans, however, the results are mixed.
If a credit card company accepts a debt settlement offer and forgives $600 or more in debt, the company must file a 1099-C with the IRS. This form notifies the IRS, which considers forgiven debt as income. As such, you’ll have to pay income taxes on this amount when you file your taxes the following year.
There are two types of student loan forgiveness. If your loan servicer forgives the loan based on the type of job you have, such as the Public Service Loan Forgiveness or Teacher Loan Forgiveness plans, the IRS doesn't consider it income.
However, if an income-based or income-contingent repayment plan wiped away $600 or more in student loan debt after 20-25 years, the IRS considers that forgiven debt as income. This income will be added to your next year's tax returns and may increase the taxes you owe.
Find out if you qualify
While debt can feel overwhelming, there are ways to calm the storm and steer your personal finances in the right direction. Debt consolidation, a line of credit or even debt forgiveness are just a few options that can help. If the latter seems to be the most practical option for you, now is the time to reach out to your creditors or the IRS and get back on track.