Defaulting on federal student loans is fairly common. The Pew Research Center reported that about 20% of federal loan borrowers were in student loan default before the CARES Act’s payment suspension was instituted. For the millions of people that defaulted on their student loans, concerns about how their debt would affect their taxes and the child tax credits were a significant issue. Many borrower advocates were worried that the government would seize the child tax credits of borrowers in default under the treasury offset program. However, the U.S. Department of Education issued a statement in February that said it would not seize refunds from the child tax credit for borrowers in default, providing relief to borrowers struggling with their debt. Continue reading to learn how your student loan default status affects your taxes.
What Is The Child Tax Credit?
The child tax credit was a dollar-for-dollar tax credit that decreased taxpayers’ tax liability. Worth up to $3,000 per child under 18 ($3,600 per child under the age of six), the credit was fully refundable. If the credit reduced taxpayers’ tax bill to $0, they could receive the remaining amount as part of their tax refund. In July 2021, the child tax credit was changed, allowing families to receive an advance credit in the form of monthly payments. Eligible families with children could receive monthly payments of $250 to $300 to help cover their living expenses. All working families that made $150,000 or less were eligible for the full credit. The child tax credit could increase families’ monthly cash flow or, for those that opted to claim the credit when filing their tax return, the potential for a significantly larger tax refund. Through the child tax credit, families could receive refunds worth thousands, putting money back in their wallets. For more information about the child tax credits and how they’re handled, visit the IRS’ child tax credit portal.
What Is Treasury Offset?
Under the current repayment rules, borrowers default on their federal student loans when they are at least 270 days late with their payments. According to the Federal Student Aid data center, approximately 9 million federal loan borrowers were in default before payments were paused in March 2020. The Institute for College Access & Success reported that about half of those borrowers are parents and qualified for the child tax credit. The problem? Under federal student loan default rules, the government can take some severe measures to recoup the money owed to it, including:
- Wage garnishment
- Loan acceleration
- Loan collections
- Treasury offset
Treasury offset is one of the harshest measures for federal student loan borrowers. With treasury offset, the government can withhold money from your federal or state income tax refunds, Social Security benefits, and other federal payments to repay the student loans you owe. When the child tax credit was announced, many borrower advocates were concerned that treasury offset would apply to child tax credit payments, and the government would seize borrowers’ payments or tax refunds once repayment began. Because so many families rely on tax refunds to make ends meet, treasury offset could be a major issue for borrowers. Depriving them of their tax refunds and the child tax credit would impose a huge financial burden.
How Does Student Loan Debt Affect the Child Tax Credit?
The payment pause and interest waiver that the government put into place to address COVID-19 will come to an end on May 1, 2022. However, the government announced that collections activities will be paused for even longer. Collections activities will be paused for six months after the COVID-19 payment pause ends, meaning collections won’t begin until Nov. 1, 2022. As part of the COVID-19 emergency relief measures for student loans, treasury offset initiatives are also postponed until Nov. 1, 2022. In a statement to CNBC, the Education Department said that it won’t withhold tax refunds, including child tax credit payments, and it will not garnish wages during this period. The pause applies to collections on loans held by the Department of Education and FFEL loans held by guaranty agencies. However, it does not apply to private student loans. If you’ve defaulted on a private student loan and the lender has gotten a court order to garnish your wages, the lender can move forward with that garnishment. However, private student loan lenders cannot seize your tax refund or child tax credits.
Student Loans and Taxes
Millions of people have benefitted from the child tax credit. Whether they opted for monthly advance payments or are claiming the credit to increase their tax refund amount, the child tax credit provided some significant relief. Many borrowers were worried about how defaulting on their student loans would affect their tax refunds and the child tax credit. While the government hadn’t previously offered clarity, it announced in February that it would not seize tax refunds or child tax credits for federal student loan borrowers in default. If your taxes feel more complicated this year — or you simply want to make sure everything is squared away and that you’ve claimed all the applicable tax credits and deductions available — working with a tax professional can be a smart idea. To find a certified public accountant (CPA) near you, search the CPAVerify database.
How to Avoid Student Loan Default
If you are having trouble making payments on your student loans, you have several options to consider before you go into default:
- Switch repayment plans to get a lower monthly payment
- Consider an income-driven repayment plan
- Refinance your student loans
- Get a deferment or forbearance
If you’re thinking about refinancing your student loans, check out ELFI.* We offer low-interest rates and multiple loan terms, and you can choose between fixed and variable interest rates. You can use student loan refinancing to tackle your high-interest private loans, streamline your repayment, or even lower your monthly payments. You can get a rate quote from ELFI without impacting your credit score.*
