If My Student Loan Went into Default, Is the IRS Going to Take What I Owe Out of Next Year's Taxes?

Written by James Hirby | Fact checked by The Law Dictionary staff |  

If you're currently in default on your student loans, you're probably struggling with a load of other financial obligations as well. Unfortunately, student loan debt is far more difficult to discharge or forgive than typical unsecured debts. Whereas debt consolidation companies can typically negotiate lower balances or interest rates on your old credit card bills, most public and private student lenders resist such overtures. Even the bankruptcy process provides limited options for destitute student borrowers. There are only a few special circumstances in which a student lender will permit a bankruptcy court to reduce or eliminate a borrower's outstanding debts.

However, your defaulted student loans don't necessarily consign you to a life of poverty. Depending upon the types of loans that you're carrying, you may have several options for reducing or eliminating your debts. If you exhibit a good-faith effort to repay your defaulted loans, you may be able to avoid serious damage to your credit score.

You may also be able to keep the full amount of each paycheck and income tax return to which you're entitled. If you refuse to continue making payments on your defaulted student loans, your lenders are entitled to petition a judge to authorize the garnishment of your wages and federal income tax refunds in order to recoup the missing funds. In most jurisdictions, these lenders may take up to 50 percent of each of your paychecks and the full amount of each of your income tax refunds. The prospect of losing multiple future tax refunds should motivate you to repay or renegotiate your past-due student loan balances.

If you prefer to repay your loans in full, your best option is to apply for a debt consolidation loan through the U.S. Department of Education. Before you can qualify for this loan, you'll need to meet a minimum credit-score threshold that may vary on an annual basis. To demonstrate that you're serious about repaying your outstanding balances, you'll also need to make at least three consecutive payments on your defaulted loans.

Once you've done this, you'll be eligible for a loan that pays off all of your student debts and consolidates your monthly payments into a single overarching credit facility. This loan will carry a higher monthly payment than each of your existing student loans. However, its interest rate may be lower. In most cases, debt consolidation loans take less time to pay down than the loans that they replace.

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