Earn more than $125,000? You may still be able to qualify for student loan forgiveness

When President Biden announced his student loan forgiveness plan last month for people making less than $125,000, borrowers with incomes just above the limit wondered if there was a way to cut back. In most cases the answer was no.

There is one exception: Some self-employed taxpayers who requested an extension to file their 2021 returns may be able to reduce their income just enough to get $10,000 in federal debt forgiveness, tax professionals say. Pell grant recipients are eligible for forgiveness of up to $20,000. The debt forgiveness program applies to individual borrowers with adjusted gross income of less than $125,000, or less than $250,000 for married couples filing jointly, based on the 2020 or 2021 tax years. (It’s line 11 on the 1040 individual tax return).

To reduce their income below these levels, taxpayers who file for an extension can make contributions to special retirement accounts for the self-employed called SEP-IRAs, tax professionals say.

The move only works for self-employed taxpayers, including small business owners, gig workers and freelancers, who report their earnings on Schedule C of the 1040 individual tax return and have sufficient cash available to fund a retirement account.

“If they’re in the sweet spot and it’s available, that’s a heck of a smart move,” says Donald Hopp, a CPA in Elgin, Ill.

Nearly 15 million taxpayers identify as self-employed, according to the Pew Research Center, and one of the reasons they tend to file for an extension is to have more time to calculate special deductions, including retirement savings incentives.

Hopp pitched the idea to a 25-year-old client with $28,000 in student loan debt. The client earned $160,000 in consulting income in 2021 and could have fallen below the $125,000 limit by making a $24,000 retirement account contribution in addition to his deductible self-employment tax payments.

“He said, ‘I really like the idea, but I don’t have the extra money in place.’ It’s a question of whether you can find the money to do it. That’s one of the struggles,” says Mr. Hopp.

Any business owner or anyone with freelance income can open and contribute to a simplified employee retirement individual retirement account, or SEP-IRA. It’s easy to open one at a discount brokerage firm like Charles Schwab or Vanguard.

Special rules let taxpayers open and contribute to a SEP-IRA for the previous tax year until they file for an extension. This year, that is Monday, October 17. A record 19 million taxpayers asked the IRS to file for an extension this year. This strategy would not work with other retirement plans such as individual retirement accounts, as the deadline to fund those accounts has already passed.

The SEP-IRA contribution limit is 20% of net self-employment earnings, with a maximum contribution of $58,000 in 2021.

“Making a SEP-IRA is one of the last efforts you can make when you’re trying to get your income down,” says Martin James, a CPA in Mooresville, Ind.

President Biden said his administration will forgive up to $20,000 in federal student loan debt for tens of thousands of Americans. Independent estimates suggest the plan will cost more than $300 billion over 10 years. Photo: Evan Vucci/AP

For a couple where one spouse has taxable W2 wages of $120,000 and the other has self-employment income of $160,000 reported on Schedule C, the self-employed spouse could contribute close to $30,000 to a SEP-IRA, bringing their combined adjusted gross income. down to about $239,000, more than needed to qualify for student loan forgiveness, according to Mr. James. A $20,000 contribution brings the number down to $249,000, just below the forgiveness limit. The calculations include deductible independent taxes.

There is a trade-off to making the SEP-IRA contributions: a reduced Section 199A qualified business income deduction, a new tax break for pass-through businesses. Those seeking to qualify for loan forgiveness should consider the smallest SEP contribution that brings them below the income limit, as it preserves more of the 199A tax credit, says Mr. James.


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“This is a situation where if I need to get my income down, I would do the SEP and ignore the fact that I’m reducing my QBI deduction. It would still make sense because the forgiveness amount is so high,” he says .

For self-employed taxpayers who are really close to the income limits, other tactics can help bring income down, Mr. James. A person using a vehicle for business can choose to take the standard mileage deduction or report actual expenses to calculate the deduction, and the latter could turn out to be a larger deduction.

Opting for the actual expense version of the home office deduction rather than the simplified calculation method could also help, Mr Hopp says.

Taxpayers who already filed their 2021 tax return by extension could make a SEP-IRA contribution by Oct. 17 and file an amended return to show a lower adjusted gross income for the year, Mr. James.

Write to Ashlea Ebeling at ashlea.ebeling@wsj.com

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