Student Loan Debt Forgiveness And The Foreign Earned Income Exclusion

Question

The US federal government currently has several student load repayment options (like the income based repayment program). At the end of some specified time period (20 or 25 years) the outstanding debt is forgiven.

This amount of forgiven debt is considered taxable income. For large amounts of student loans, the minimum payment amount is insignificant; the outstanding loan balance will grow exponentially over the 20 or 25 years.

The Foreign Earned Income Exclusion is another program that allows US workers to deduct a significant amount of their taxable income. For a married couple, I believe the amount is currently 195k. If a married couple, participating a student loan forgiveness program was overseas and met the appropriate conditions, would they be able to reduce their tax liability on the loan forgiveness?

My understanding is that it only applies to 'foreign earned' income; but assume the student attended a University outside of the US. IE - they went to school in a foreign country and were abroad when the loan was forgiven.

My assumption is 'no, this will not work' but I was wondering if anyone had any thoughts.

Answer 1

Debt forgiveness is not earned income. Foreign income exclusion applies only to earned income, i.e.: salaries and self-employment active income. Essentially, as a rule of thumb, you can check whether you're paying FICA/SE taxes on the income. If you are (or would be, if you were getting the exactly same income in the US) - it probably qualifies for the exclusion. Any other income, including debt forgiveness, doesn't.