LIPP assistance with respect to education loans should not be considered taxable income if the participant works for a government agency or a tax-exempt section 501(c)(3) organization and receives the repayment assistance in the form of a loan that is later forgiven. For this reason, recipients of non-taxable LIPP awards must sign a promissory note for the amount of any LIPP assistance. These LIPP loans are then forgiven in the following year provided the graduate has complied with the rules of the program.
For graduates working in LIPP-eligible jobs in the private sector, at organizations without 501(c)(3) status, or within Harvard University, LIPP assistance is reported to the IRS as “other income” for the tax year in which it was received, and a Form 1099-MISC is issued (with LIPP assistance reported in Box 3). In those instances, the LIPP award includes an additional 25% allowance toward the federal income tax liability, and the LIPP assistance is not awarded as a loan.
What about the student loan interest deduction?
The IRS has indicated in Publication 970 that interest payments do not qualify for the student loan interest deduction if “you are not legally obligated to make payments on the loan.” This appears (based on the examples in Publication 970) to include payments made with assistance from others. You should consult a tax adviser to determine what portion, if any, of your annual student loan interest is deductible if you receive LIPP assistance.