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If you have federal student loans, you already know the government has paused monthly payments and interest on eligible loans several times now, only to extend the deferment through September 30, 2021 as part of a COVID relief plan. This move has been a godsend for people who may have been out of work during the pandemic, as well as those who saw their incomes drop due to a decrease in work hours or any other reason.
Some experts believe the current pause on monthly payments and interest could be extended through the end of the year, or perhaps even longer than that. What happens next remains to be seen, but at the moment, borrowers should definitely prepare to begin making payments on their federal student loans starting in October.
Also, those who were in default on their loans should find a way to get back on track with their payments. Not only are payments on federal student loans due once again after September 30th, but collection activity on defaulted student loans is set to resume.
Defaulted Student Loans And Your Taxes
There are numerous reasons to avoid defaulting on federal student loans (or private student loans for that matter) if you can help it. For example, let’s say you miss a monthly payment and become delinquent on a federal student loan. If you remain delinquent for 90 days or longer, your loan servicer will report the delinquency to the three credit bureaus, causing your credit score to take a huge hit.
Once you’re delinquent for at least 270 days, your student loans are officially in default. At this point, the entire unpaid balance of your loan is now due under a process known as acceleration. Worse, you lose eligibility for federal student aid and your wages could eventually be garnished. Your loan servicer can also take you to court.
MORE FOR YOU
In an interesting twist that is especially relevant right now, your tax refunds and federal benefit payments may be withheld and used to repay your defaulted loan using a process called “treasury offset.”
According to Mark Jaeger, Vice President of Tax Operations at DIY tax prep solution TaxAct, this can mean never seeing a portion of your refund or all of it after you file your 2021 tax return.
“For obvious reasons, that may be impactful to individuals who rely on that refund money to pay bills or cover the cost of other large purchases,” he says.
At the moment, many students are also worried about treasury offsets coming after the advanced child tax credits that are starting to be paid out now.
The advanced child tax credit program was created to help families get an “advance” on the child tax credit they would normally claim when they file their taxes in 2022 for the 2021 tax year. However, borrowers should know that advanced child tax credits are subject to a different set of rules so they won’t be seized if you’re in default on federal student loans.
According to the United States Bureau of the Fiscal Service, “the Advanced Child Tax Credit payments, authorized by the American Rescue Plan Act, are not subject to offset for any reason through the Treasury Offset Program (TOP).”
With that being said, child tax credits you apply when you file your 2021 tax return next year will be subject to offset.
Steps For Borrowers In Default
Mark Kantrowitz, who is a student loan expert and the author of How to Appeal for More College Financial Aid, says borrowers in default can rehabilitate their loans by making nine out of 10 consecutive, full, reasonable and affordable monthly loan payments, pursuant to a loan rehabilitation agreement. However, borrowers who entered a loan rehabilitation agreement before or during COVID get a leg up.
“During the payment pause and interest waiver, the paused payments were counted as though they were made for the purpose of loan rehabilitation,” he says. “This means that borrowers who had a loan rehabilitation agreement will have their loans rehabilitated when the payment pause and interest waiver ends.”
Kantrowitz went on to explain that, once a defaulted loan is rehabilitated, the default is removed from the borrower’s credit history and collection efforts end. At that point, he says, there will be no wage garnishment, offset of income tax refunds or reductions in Social Security disability and retirement benefit payments.
If your loans are not currently under a loan rehabilitation agreement, you can learn how to utilize this program here. Federal student loans that become part of a loan rehabilitation agreement become eligible for deferment, forbearance, choice of repayment plans, loan forgiveness plans, federal student aid and removal of the record of default from your credit history.
The Bottom Line
As a side note, those who believe their tax refunds will be intercepted when they file their 2021 taxes can also take steps now to ease the blow. Eric Bronnenkant, who serves as Head of Tax at Betterment, says borrowers can reduce their withholding on their paycheck by adjusting their W-4. Doing so can lessen or eliminate any tax refund they might receive, which comes with pros and cons. For example, there are benefits that come with receiving more money in your paycheck now, yet not getting a tax refund next year could hurt.
Also be aware that you shouldn’t be suddenly surprised by treasury offset. Financial attorney Leslie Tayne says borrowers in default will likely receive a tax offset notice months before filing returns, so you’ll have some time to plan.
Either way, Tayne says borrowers should contact their loan servicer and explain their financial hardship to enter a repayment plan or loan rehabilitation process which can stop tax garnishment. Additionally, those that repaid their debt should receive their refund back, she says.
“Getting out of loan default and communicating with lenders is one of the best things you can do to avoid student loan tax garnishment.”