Will Student Loan Forgiveness Impact Your Taxes?
Among the many changes President Joe Biden has implemented since being sworn into office, student loan forgiveness seems to have been a major focus. He has pushed for student loan relief and loan forgiveness in many of the bills he’s introduced. And if you have student loan debts that you’re hoping to have forgiven, it’s important to understand how existing and new tax laws may impact that loan forgiveness. Keep reading to learn more.
Loan Forgiveness Not Currently Tax Free
One major obstacle in the way of widespread student loan relief is the fact that student loan forgiveness is not currently tax free. While having tens of thousands of dollars in student debt erased might sound well worth a slightly larger tax payment, don’t jump to conclusions. The tax expense can be quite significant for some, and you’ll be expected to pay it all at once.
Let’s look at an example. Let’s say you earn $50,000 a year, and you have a tax rate of 22%. Then, you have $30,000 in student loans forgiven. The IRS currently looks at the forgiven amount as taxable income. In essence, it’s as if someone gave you $30,000 and you put it all towards your student loan. Now, your taxable income is $80,000 for the year.
While other factors would impact the final amount you owe, you could be slapped with a tax bill of up to $6,600 simply due to your student loan forgiveness. Of course, owing $6,600 is a lot less than owing $30,000, but again, you’re expected to pay it all at once.
Forgiveness through Current Payment Plans
Student loan forgiveness isn’t just something that’s passed at a federal level. Of the 45 million student loan borrowers in the country, about a third of them are currently on “income-driven repayment plans.” These plans strive to make payments more affordable by capping their monthly payments at a certain percentage of their income. After 20 or 25 years (depending on your specific plan), the remaining amount is cancelled.
Under the existing tax laws, as mentioned above, any forgiven amount would be treated as taxable income, and you’d receive a 1099-C from the IRS reporting that income amount. It doesn’t take any insanely large amount of forgiven debt for your tax bill to take a significant leap either.
Here’s one more example: Let’s say a borrower earns anywhere between $85,000 and $160,000. This would put them into the 24% tax bracket. If they had $48,000 in student debt cancelled, they would need to pay $11,520 to the IRS, in addition to any taxes they would normally owe.
The Student Loan Tax Relief Act
Among President Biden’s other pushes for student debt relief is the Student Loan Tax Relief Act, which was included in the $1.9 trillion COVID stimulus bill he introduced. Under this act, any amount of student loan debt that is forgiven would not be considered taxable. Currently, this provision would only last through 2025. However, there is the possibility that it could be extended, or even become permanent.
At the moment, borrowers on the income-driven repayment plans described above would be the ones to see the most benefit. However, if current pushes for more widespread student loan forgiveness are successful, this act would predict all borrowers from additional taxation on their forgiven debts.
Current Tax-Free Forgiveness Programs
It is important to note that there are other student loan forgiveness programs that are not taxable. These include a forgiveness plan for borrowers who are completely and permanently disabled, as well as one for public servants employed by a US federal, state, local, or tribal government, or by a non-profit organization. If you qualify for loan forgiveness under these programs, your forgiven student loans would not impact your tax liability.
The former relief program (known as a total and permanent disability, or TPD, discharge) has also received its own updates in the wake of the COVID-19 pandemic. Typically, borrowers must certify their annual earnings during the first three years after applying for a TPD discharge or else risk having their loans reinstated. This requirement was temporarily waived in March of this year, and all borrowers’ loans were reverted to a discharge status if they were reinstated on or after March 13, 2020.
While student loan forgiveness would no doubt be a relief to millions of borrowers, the current taxability of the forgiven amount could create new financial burdens on the very people it’s meant to help. If you want to know more about how having your student loans forgiven might impact your personal taxes, contact us. We’ll go over your unique financial situation and let you know what to expect regarding your student loans and your taxes.
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136 N. Orchard Street, Suite 8
Ormond Beach, FL 32174