We received an email from Steve with an interesting tax question.

Steve writes:

I have $30,000 left on school loans I’ve been paying on for years (no late payments). My family wants to pay them off for me so it’s done with. What is the best way to do this? Do I have them gift me the money, then I pay it off? Or have them directly pay it off? What does each option have to do with taxes when the time comes?

Thank you for the help.


In summary, Steve is about to be the lucky recipient of a large sum of money from his family. He intends to use this money to pay down his student loans. He would like to know if there are any tax consequences of the gift.

Unfortunately, this kind of gift can trigger a gift tax bill. The good news is that there are ways of avoiding this particular taxation.

In this Article:

Student Loan Payments and the Gift Tax

Under federal tax law, a gift is when you give money (or any property) to others without the expectation that you will receive something of at least equal value in return. You might be making a gift even if you make an interest-free or reduced-interest loan.

When you make a gift, you trigger the “gift tax.” There are exceptions to that trigger such as gifts to a spouse, medical payments, and tuition payments. Unfortunately, student loan payments do not fall within those exceptions. Additionally, the IRS excludes gifts that you give annually if they are under a certain value. In 2021, that value is $15,001. In other words, if you give $15,000 to your family member for student loan payments, you do not have to pay the gift tax.

Like an inheritance, the person making the gift is usually the party responsible for paying the gift tax.

It is also worth pointing out that whether a gift goes directly or indirectly to someone, the tax is still incurred. This means that whether Steve’s family gives him the money directly or just pays off his student loans, they still might have to pay the gift tax.

For more details on gift tax basics, be sure to check out the IRS Frequently Asked Questions on Gift Taxes. Borrowers can find detailed instructions on how to file for the gift tax in IRS Publication 559.

The good news is there are a few ways in which Steve and his family can potentially avoid having to pay any gift tax.

Avoiding Gift Taxes on Student Loan Payments

One of the most common ways to avoid gift taxes is to spread the money out over several years. Steve’s family could give him $15,000 in 2020 and then another $15,000 in 2021 without triggering any gift tax.

The gift tax also treats spouses as individuals. That means Steve’s mom and dad could each contribute $15,000 in 2020 without having to pay any taxes. If Steve received $15,000 from his mom, dad, grandpa, and grandma, he would get a total of $60,000 without any family member having to pay a gift tax.

Student Loan Exception to the Gift Tax

There is one scenario in which a student loan payment from the family may not be subject to the gift tax.

According to the Wall Street Journal payments made by a co-signer towards a student loan are not subject to the gift tax. This is because payments by a co-signer or not gifts at all. It is merely repayment of a debt owed. For example, if Steve’s mom co-signed his student loans, she is legally responsible for the debt just like Steve. As such, if she paid off a student loan that she was the cosigner on, she wouldn’t have to pay a gift tax on the payment, even if it was more than $15,000.

Paying More than $15,000 on Student Loans

Suppose the full $30,000 from Steve’s email comes from a wealthy uncle, Fred. Fred didn’t co-sign the loan and he is unmarried. Accordingly, he can exclude only $15,000 from the gift tax. The remaining $15,000 is a taxable gift. Even in this circumstance, though, Fred can avoid the gift tax. Fair warning, this discussion gets a little technical.

The IRS offers a lifetime credit, commonly referred to as the unified credit. The unified credit allows Fred to avoid estate taxes when he dies, up to a certain value. As of 2020, the allowable credit was over 4.5 million dollars.

The IRS allows Fred to use that credit while he is still living. To use this credit towards the taxable $15,000 (the $30,000 gift –  the $15,000 annual exclusion), Fred needs to file a special return and determine the tax he owes on that amount. For the sake of ease, let’s assume Fred has calculated how much gift tax he owes on the $15,000 and has determined that he owes $1,000. Instead of paying the $1,000, Fred can use $1,000 of his unified credit, thereby avoiding paying for the gift tax. Note: When he dies, his unified credit will be reduced by $1,000.

More on the unified credit can be found on TurboTax and these IRS instructions.

In other words, student loans can be paid off by family members (or non-relatives) without paying any gift tax… as long as you file the proper paperwork.

Bottom Line

Large contributions towards student loan debt are subject to the federal gift tax.

However, there are a number of ways in which borrowers and their families can avoid this tax.  Whether you give the money or receive it, make sure to get familiar with these concepts. Once you have your mind wrapped around the basics, be sure to discuss your different options with an accountant to ensure you don’t violate any IRS rules.

Finally, keep in mind that this article just focuses on federal tax issues. Your state may have their own gift taxes that could be triggered by a student loan gift. As with any technical tax question, it is always best to discuss your options with a local tax expert.

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