What physicians with student loans need to know.
With tax season approaching, many people are focused on gathering all the tax forms to make sure they don’t miss the April deadline; however, few will pause to inquire how their tax filing could impact their student loan payment. Fortunately, there are many ways that borrowers can get creative with income reporting come tax season that could impact their student loan payments substantially. With the student loan debt in the US being one of the government’s largest assets on their books, you would be right in assuming that the repayment plans and options are less than straight forward. As they say though, through complexity, strategy is born and so let’s look at some ways to use the complexity of the student loan world to your advantage.
How is your student loan payment calculated?
A common misconception that borrowers have is that their payment is calculated based on the total amount of debt they have outstanding.This creates a heavy burden for lower earning borrowers who recently graduated and have a high amount of debt and leads many to question: How will I ever pay this off?I am going to have to work forever!The good news is that there is a beautiful thing called Income Driven Repayment Plans.
Income driven Repayment Plans
Income Driven Repayment (IDR) plans are available to all Direct loan borrowers with the federal government, and they allow borrowers to make a payment based off their income and household size; NOT the total amount of loans outstanding. There are several different types of IDR plans including PAYE, REPAYE, IBR, and ICR. We won’t dive into the nuances of the various repayment plans but the important thing to understand is how they report your income.
The Payment Calculation
The monthly student loan payments are a percentage of what’s called your discretionary income.For most of these plans, your discretionary income is classified as the amount by which your income exceeds 150% of the poverty guideline for your family size.Your annual payment will be 10% of your discretionary income amount in most repayment plans. This calculation does go off the Federal poverty lines and so yes, leave it to the Department of Education to make the amount of discretionary income for someone in New York City the same as someone living in Albuquerque. Regardless, this is how they derive your payment amount and a key component to understanding the reporting strategies.
Income Numbers Used
The other important rule to note is that you can report your most recently reported tax return (if it was within 2yrs) and they will use your Adjusted Gross Income off your return OR you can submit pay stubs for them to identify your gross income. Your Adjusted Gross Income, otherwise known as your AGI, is found on Line 11 of Form 1040.This is the form you complete and send to the IRS when filing your taxes.It is equal to the total income you report that's subject to income taxes—minus pretax deductions, or adjustments that you're eligible to take.
Another rule that we must acknowledge is that if you file your taxes jointly as a married couple, all the IDR plans will take your and your spouse’s joint income into consideration when calculating your payment even if you simply report off your paystub. That said, there are certain payment plans that will allow you to file your taxes separately to isolate your sole income for student loan reporting's sake. This means that they will look at your income alone when determining your discretionary income instead of looking at your and your spouse’s income jointly, which can save thousands of dollars annually in some instances.
Why would you want to lower your payment?
You might be asking yourself why you would want to reduce your payment? Wouldn’t that just mean that I will eventually have to pay more interest over the long haul? Not necessarily! The clients that are looking to lower their payment for strategic reasons fall into two camps: they are either pursuing a forgiveness program or they are looking to take advantage of interest subsidies available.
If you are not familiar with the forgiveness plans available within the Federal system, they can be broken up into two categories: Public Service Loan Forgiveness (PSLF) and a Long-Term forgiveness program. When it comes to the PSLF program, this is a 10yr program that allows for total, tax-free forgiveness of your loans if you make payments on an IDR plan while working for a qualifying employer (non-profit, government, university etc.) for 120 months. As you can see, there is a MAJOR incentive for folks to reduce their payment on a program such as this since every dollar saved on payments is a dollar not having to ever go towards their loans!
The other forgiveness program is what we call a long-term taxable forgiveness program. Many of the IDR plans offer a forgiveness plan at the end of a 20-25yr timeframe. If you have made payments for that long and still hold a balance on your loans, they allow you to throw in the towel and they will forgive your remaining balance. As you can imagine though, there is no such thing as a free lunch when it comes to this government program and thus, they will add the forgiven amount to your taxable income in that final year. This can create an exceptional tax burden for you down the line but in many instances, this could be a substantially more efficient path than just paying them off aggressively. Given this, we will also want to minimize your payment if we are pursuing a plan like this to maximize the forgiveness allotted to you.
Even if you are in a situation where you might not qualify for any of these forgiveness programs, there is still an argument for pursuing an IDR plan and aiming to minimize your income reporting due to a great plan called the Revised Pay As You Earn (REPAYE) plan. This IDR plan allows for you to get half off your “unpaid interest”. Since these plans are based off your income and not the size of your loans outstanding, there are many instances that your payment is much lower than even the interest accrual on your loans. This is a bad word in the financial world that we call “negative amortization”. As a hypothetical example, if you have $300k of loans outstanding that are accruing $1,700/mo in interest, yet your IDR payment is only $300/mo since it is based off a prior lower income, you would have $1400/mo in “unpaid interest”. This amount would typically be added to your total owed, however, on REPAYE, they cut that number in half. I know you might want to pay aggressively on your loans but let’s not throw $700/mo (in this situation) out the window if we can avoid it! Keep in mind, everyone’s situation will be different and there are have also been formal proposals for an updated REPAYE plan that would eliminate unpaid interest altogether but we can’t make any decisions off this until it is finalized an in law. 
How can you reduce your reported income on paper?
Now that we understand the rules and the reason for wanting to reduce our reportable income for student loan's sake, let’s talk strategy. Since the Department of Education uses your AGI, this means that we can reduce that number through pretax deductions like retirement plan (401(k), 403(b), TSP, 457b, SEP, SIMPLE IRA, etc) as well as HSAs, individual retirement accounts, or alimony. Most of our clients have access to an employer retirement plan that may allow you to contribute up to $22,500 each year on a pretax basis. This would therefore reduce your adjusted gross income commensurately. By reducing your AGI by $22,500/yr, this could reduce your payment by about $187.50/yr on some plans and even up to $281.25/mo on other repayment plans! Keep in mind that this is simply a way to reduce your student loan payment and there are strong arguments suggesting that making contributions on a Roth basis to those retirement plans could end up saving you more in taxes than you did on the student loan front. Tough to run the exact numbers without having that crystal ball of future income/tax rates and so be sure to discuss the pros and cons with your financial team.
For our married clients, the tax filing status is incredibly important. Another perk to the rule that you must report off your AGI on the tax return is that we are able to have you file separately from your spouse to isolate only your income for reporting's sake. This is incredibly important for folks who have a spouse who have a high income that you don’t want to be included in your monthly payment calculation. As an example, if you have a spouse that is making $150k/yr, filing taxes separate could save you upwards of $1250/mo ($15k per year!) on your student loan payment in some instances. Although this is a big number, filing taxes separate comes with its own list of pros and cons and so it will be important to have your student loan advisor connect with your CPA to evaluate the options. If you save more by filing your taxes jointly (on the tax side) than you do by filing separately (on the student loan side) then it is likely not worth it to file separately. There are also tax benefits that you could be missing out on by filing separately but at the end of the day, it is simply a math problem. By running both scenarios, the answer will be clear as day.
For those of you in one of the lucky few “community property” states, you also have another lever we can pull on for you. AZ, CA, ID, LA, NV, NM, TX, WA, and WI are all community property states which means that all income that is earned annually by you and your spouse is legally considered community property. This means that when you file your taxes separately, instead of simply being able to isolate your income from your spouse’s, you can also submit additional paperwork (Form 8958) to have them draw that line right down the middle. As an example, if you are making $300k and your spouse is making $100k, in a normal filing taxes separate situation, you could isolate your $300k of income and must report that to the Department of Education for your payment's sake. But in a community property state, you get to cut your household income of $400k directly down the middle. You can report it as if you made $200k and your spouse made $200k. This means that when you go to report your income, you get to report the $200k instead of the $300k of income! This can be HUGE savings for clients and the bigger discrepancy between your and your spouse’s income, the more impact this will have on your situation.
How could filing an extension help you save money?
If you are playing the game right, we typically like to see our clients reporting based off their income from 2yrs in arrears. This is typically can be a lucrative approach for our clients going through a major income change as we can effectively delay the impact of that income change for a couple of years. Since you must report off your most recently completed tax return though, there are some instances that filing a tax extension could be beneficial for you. As an example, if you file an extension on your 2022 taxes and don’t file them until October 2023, if we go to report your income to the Department of Education in September of 2023, your most recently completed tax return would still be from the year 2021 (hence the two years and arrears). Since this is your most recently completed tax return and it is within 2yrs, this would allow you to make payments based off that 2021 income for 12 subsequent months after you report that income. This means that you could be making payments based off your 2021 income all the way through September of 2024. With the recent COVID extensions many of our clients no longer need to file extensions but depending on your situation, it could be substantially beneficial.
For those that are not enrolled in a repayment plan yet or have recently discovered that they are on the wrong plan and need to make a change, filing an extension on your 2022 taxes could be beneficial as well. Typically, when you enroll in a repayment plan or make changes to your repayment plan, they capitalize your interest. This means that any of your unpaid interest gets added to your principle... meaning you will be earning interest on your interest which is less than ideal. After July 2023, they are doing away with that, and you will be free to switch repayment plans without having to capitalize any interest. For folks that made less in 2021 and get on a different plan, we are often advising them to file an extension on their taxes this year to report that lower income.
As you can see, the tax world and the student loan world can get quite intertwined, so it is important that you have your CPA/tax professional and your student loan advisor collaborating for you. Many will want to lean on their loan servicers for guidance, however many are incredibly well intentioned, yet are simply untrained in repayment strategies. As you can see though, there are opportunities for you to let the complexity work to your advantage and surround yourself with professionals to guide you through it. Identifying financial professionals with a Certified Student Loan Professional (CSLP) designation will be a good indicator for you to know that they can be the student loan strategist on your financial team and your CPA will be a key aspect of making these plans work to the nth degree of the law, in your favor.
Michael Foley, CFP, CSLP, and Hannah Flodin, CSLP, are comprehensive financial advisors at North Star Resource Group with a specialty in serving the medical community. They are accepting new clients and so feel free to contact their team at FoleyTeam@northstarfinancial.com to schedule a complimentary, no obligation initial consult. Financial Professionals do not provide tax advice and this should not be considered as such. Please consult a tax professional for advice regarding your specific situation. 5479586/DOFU 3-2023. Michael and Hannah are registered representatives and investment advisor representatives of Securian Financial Services, Inc. Securities and investment advisory services offered through Securian Financial Services, Inc. Member FINRA/SIPC. North Star Resource Group is independently owned and operated. 6720 N. Scottsdale Rd, Suite 290 | Scottsdale, AZ 85253.