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A key provision that makes student loan forgiveness tax-free is included in the $ 1.9 trillion federal stimulus package that is making its way through Congress and likely to be signed into law soon.
Currently, any student loan canceled by the government can be considered taxable and charged at the borrower’s normal income tax rate.
For example, if someone earns $ 50,000 a year, has a 22% tax rate, and has received $ 30,000 in student loan forgiveness, he / she could be slapped with a $ 6,600 bill from the IRS.
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Borrowers will soon be able to withdraw from these payments.
Which borrowers can save
There are approximately 45 million student loan borrowers in the US.
One third of these borrowers are enrolled in “means-tested repayment plans”. These plans aim to make borrowers’ payments more affordable by limiting their monthly bills to a percentage of their discretionary income and by canceling their remaining debts after 20 or 25 years. At that point, their forgiven loans are treated as income and the IRS sends the borrower a form called 1099-C.
“It’s as if someone gave money to the borrower to pay back the debt,” said higher education expert Mark Kantrowitz.
The tax bill can be significant: Suppose a borrower earns anywhere from $ 85,000 to $ 160,000, with a tax rate of 24%. If the government had waived $ 48,000 in student debt, they would have to issue the IRS with a check for $ 11,520, according to an example from Kantrowitz.
The Student Loan Tax Deduction Act, introduced by Senator Elizabeth Warren, D-Mass. And Senator Bob Menendez, DN.J., now part of the incoming stimulus package, would end this policy. Any forgiven student debt does not affect a borrower’s tax liability.
The provision would last until 2025, but could be extended or become permanent.
Borrowers with income-driven repayment plans would be most affected by the change. Other plans for canceling student debts, including one popular for government officials and another that cancels the debt for those with severe disabilities, are already not taxable.
A good sign for debt cancellation?
Proponents also hope that tax-free cancellation of student loans will remove an obstacle to President Joe Biden’s forgiveness of student debt.
“This will pave the way for President Biden to provide real assistance to student borrowers without fear of facing a massive tax bill they cannot afford,” Ashley Harrington, federal advocate at the Center for Responsible Lending, said in a statement. statement about the weekend.
Critics of student loan forgiveness claim it won’t boost the economy, as graduates are generally higher earners who put their monthly payments into savings and don’t spend more. Others say a debt anniversary is unfair to those who have already paid off or never took out their loans, while sending the message that it’s okay for people to cancel their debts.
Proponents, meanwhile, say student loan borrowers were already in crisis before the pandemic – with a third of borrowers in arrears or default – and that the pain has only gotten worse after a year of record high unemployment. They also point out that it is people of color who have suffered most from the credit crunch, and that it is also black and Hispanic Americans who have suffered the most financially from the coronavirus pandemic.
Biden says he supports $ 10,000 in student loan forgiveness, but he is under increasing pressure from members of his own party, attorneys and borrowers to go ahead and cancel $ 50,000 per borrower.
If that forgiveness became tax-free, $ 10,000 in cancellation would save the average borrower about $ 2,000 in taxes, according to a rough estimate by Kantrowitz. If $ 50,000 per borrower were to be canceled, the average person would avoid a $ 10,000 tax bill.
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