Want to Help a Loved One Pay Down Student Loans? Here are Three Ways Around Gift Taxes

By Rachel Puryear

Do you have a loved one who took out student loans to pay for education, and you now wish to gift loan repayment to them? Perhaps you were unable to help your loved one while they were in school, but you have since become better able to do so, and want to help.

Although paying for someone’s tuition at the time that they go to school is exempt from gift taxes (so long as you pay directly to the institution), helping someone later repay their student loans is not exempt. Nonetheless, here are three workarounds to help someone repay their loans without incurring gift taxes.

A neat roll of cash with a $20 bill on the outside, wrapped in a red bow, with soft lights out of focus in the background.

(1) If a Cosigner Pays Off Any Amount of a Loan, it’s Not Considered a Gift:

If a student borrower has a cosigner on their loans – regardless of whether the cosigner ever received or used any of the funds – the cosigner may pay off any part of or all of the loan; without incurring gift taxes to themselves, or income tax to the primary borrower. Paying off a loan that one themselves is obligated on is considered satisfaction of a debt owed, and not a gift. Nor is it income to other borrowers on the loan.

What if you were not a cosigner on the original loans? There’s a solution to that situation. The borrower can refinance the loan, and add you as a cosigner to the refinanced loan. Then, once you are a cosigner on the loan, you can safely pay it off.

For example: Let’s say that Marie wants to help her son, Sean, pay off his student loans. Marie earns significantly more now than she did when Sean was in school, and she is now better able to help him pay them off. However, Marie is concerned about gift taxes. Marie has good enough credit to qualify as a cosigner.

Therefore, Marie and Sean together refinance Sean’s loans, with Marie as a cosigner. Now that Marie is obligated on the loan, she can pay off any or all of Sean’s outstanding loan amounts, without incurring gift taxes.

Tip: Make sure there’s no prepayment penalty on the new loan, if you pursue this option and intend to pay off the debt quickly. Also, shop around for fees associated with the loan.

The downside to this solution is that depending on your credit, you may or may not be able to qualify for the new loan. If this option is not viable for you, see below for further options.

(2) Gifts Could Be Spread Out Over Multiple Years, and/or Made To and From Multiple People:

Gift taxes only start to become a concern where one giver gifts more than $15,000.00 to one person in the same year (for non-exempt gifts). However, that amount applies per giver, and per recipient.

For example: Frank is unmarried, and wants to help his daughter, Diane, pay off her student loans. Diane owes $80,000.00 in student loans. Frank would have gladly helped Diane pay for her education while she was in school if he could have done so, but he could not afford to do so while she was in school.

Recently, however, Frank inherited enough from his mother’s estate to pay down Diane’s balance. Frank does not have good enough credit to qualify as a cosigner.

Frank could (at the time of this post) gift up to $15,000.00 a year to Diane before having to worry about the gift tax. However, if he did this, it would take several years to pay off Diane’s loans.

However, let’s say that instead; Frank is married to a spouse willing to help pay Diane’s loans, and Frank is also able to persuade his sister to help pay down Diane’s loans. In a single year; Frank could gift $15,000.00 to Diane, Frank’s spouse could also gift $15,000.00 to Diane, and Frank’s sister could gift another $15,000.00 to Diane.

In this scenario, the family helps pay down $45,000.00 of Diane’s loans in the same year, without needing to worry about gift taxes, or report the gifts. This significantly shortens the timeline for paying off Diane’s loans, compared with the previous scenario.

If Diane is married, any of the above benefactors could also make the same gifts again to Diane’s spouse, without incurring gift tax liability. However, it would be up to the spouse to put the money towards Diane’s loans. Gifts between spouses are exempt from gift taxes – so if the spouse is willing and able, the spouse could put unlimited funds towards Diane’s loans.

(3) Another Way to Avoid Gift Taxes if You Pay Off Large Amounts of Someone Else’s Student Loans:

Let’s go back to the example of Frank and Diane, where both Frank and Diane are unmarried. Refinancing Diane’s loans together is not a viable option, and going through multiple givers and receivers is unfeasible for them. Frank wants to fully repay Diane’s loans immediately, however.

Frank has another option in order to avoid a gift tax problem. The IRS has a (very technical!) procedure which, if followed correctly, allows a giver to avoid paying taxes on non-exempt gifts – so long as such non-exempt gifts given over the giver’s lifetime do not exceed federal and state limits.

Frank can gift the funds – either directly to Diane, or directly to her creditors – and then report the gift to the IRS with his tax return at the end of the year according to the specific procedures described here for unified lifetime credit. Here‘s also Frequently Asked Questions from the IRS on gift taxes.

Note: The procedure for this option must be followed correctly to get the tax benefit. Also, the statutory federal (and possibly state, depending upon where you live) unified lifetime credit limits change over time (usually increasing). So the current limits will likely change in later years. Be sure to seek financial advice from a qualified advisor in this type of situation.

Another note: Making an interest-free or even low-interest loan to someone else – such as to help them pay off debt – could also be considered a gift. Consult a qualified advisor before doing this.

Helping loved ones pay off student loans should be encouraged just as much as paying tuition up front and accordingly exempted as such – rather than being subject to gift tax laws which unfairly disfavor families of students who needed to take out loans because they could not afford to pay up front. In the meantime, I hope that these strategies for avoiding gift taxes for helping a loved one pay off student loans is helpful for you and your family.

Thank you, dear readers, for reading, following and sharing. Here’s to your getting the education you need, and helping your loved ones get it, and without having to pay taxes that the wealthiest families can avoid.

If there is something you would like to see addressed on this blog, please reach out to me here to ask. If you want to see more content like this and you don’t already subscribe, click here to get the Free Range Life and Work newsletter!


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