Defaulting on your student loan can lead to wage garnishment without your consent, which can severely cut into your income. The garnishment, which is a percentage of your disposable income, is taken from your paycheck after taxes. You'll still use your gross pay, listed on your W-2, when filing and paying your income taxes. In a sense, it's just like making a voluntary student loan payment, as you do not receive any special tax deductions or credits for the amount garnished from your earnings.
You file and pay taxes based on your taxable income, which is your gross income less applicable tax deductions, credits and allowances. Your wage garnishment does not affect your gross pay, but can affect your net pay – the amount left after tax withholding, FICA taxes and other paycheck deductions.
Deducting Student Loan Interest
You may still qualify for the student loan interest deduction if your loan is in default status. You should receive a form from your loan servicer documenting the total interest you paid on the loan for the tax year. If you meet the other requirements, like using the money only for eligible education expenses, you can take the deduction. You can also claim this deduction for other school loans not in default.
The Department of Education can seize your tax refund until your student loans are paid off. However, you must be notified in advance of the intent to offset any tax refunds. This notification also details your right to appeal the process if you think an error has been made. If you're married and the debt is yours alone, you may be able to stop your spouse's refund from being used for your defaulted loan.
Getting Back on Track
You can't discharge a federal student loan through Chapter 7 bankruptcy, but you may be able to set up a monthly payment plan – less than the amount of your wage garnishment – with a Chapter 13 bankruptcy filing. You can also attempt to rehabilitate the loan by making nine on-time payments over a 10-month period. Contact your loan holder to determine your eligibility for this option.
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