Covid-19’s $ 1.9 trillion stimulus project makes pardoning the student loan tax free

Included in the $ 1.9 trillion stimulus package is a clause that makes student debt forgiven tax-free. Pressure increases for President Joe Biden to cancel student debt, but it is also big business for many borrowers independently.

The provision, added to the Covid-19 relief project by Senate Democrats and advocated by Sens. Bob Menendez (D-NJ) and Elizabeth Warren (D-MA), says that anyone whose student loans are canceled by 2025 will not have to pay tax consequences. Debt cancellation is generally treated as taxable income, so without it, if someone were to forgive some or all of their student debt, they would be accompanied by an invoice.

Although student debt forgiveness was a rather marginal idea, it has become much more common in recent years, as student debt in the United States has grown. Currently, about 45 million borrowers owe $ 1.7 trillion in student loans.

Biden supported Congress by forgiving $ 10,000 in student loan debt per individual. However, Senate majority leader Chuck Schumer, Warren and progressive representatives Ayanna Pressley (D-MA), Ilhan Omar (D-MN), Alma Adams (D-NC) and Maxine Waters (D-CA) asked the president to cancel $ 50,000 using executive action. Biden said he does not believe he has the authority to cancel student debt.

A big question in the background has been whether, if some forgiveness happened, people would face taxes. The stimulus package removes that obstacle from the path.

While the political impetus to include this tax clause in the relief bill may have been broad-based forgiveness, this is a solution that many policy experts have long advocated and believe needs to be made permanent. Many student loan borrowers have income-based repayment plans, in which they make payments on their loans based on their income and, after 20 or 25 years, these loans are forgiven. Few borrowers have reached that limit of 20 or 25 years yet, but when they do, without making forgiveness tax-free, they will be taxed.

“First, the objective was to make a correction that was essentially aimed at breaking down that potential barrier to administrative action in the broader debt cancellation … but it has side effects that are important,” said Jessica Thompson, associate vice president of the Institute for College Access and success. “It is the right policy.”

The current tax treatment on student loan forgiveness doesn’t really make sense

Fiscal responsibility for student debts forgiven was determined in a strange and uneven way. In some circumstances, the IRS considers taxable income from loans forgiven; in others, no.

Loans forgiven under the public service loan forgiveness program, which forgives debts after people make 10 years of payments while working on certain public service jobs, are not considered taxable. However, loans forgiven based on repayment based on income are. Few people have qualified for forgiveness in these types of programs yet, because the programs have not been around long enough, but as more people begin to qualify, the issue of taxes is approaching.

“We are still at the beginning of the period of forgiveness,” said Thompson. “But there are more than 8 million people on these plans now, so that number is going to grow more and more. Let’s start to see examples of people receiving tax bills. “

It is not difficult to see why this would be a problem: many of the people who spend two decades paying loans do not have a high income. “These are people whose balances have been growing because they don’t even make enough to cover their interest payments,” said Thompson.

The Obama and Trump administrations have found ways to ensure that loans granted to people who have attended colleges that have committed fraud or closed down are not taxed. It is likely that the Biden government would have taken similar action, but now with the stimulus bill, this makes the tax stance much clearer.

The proposed new rule is based on a tax provision included in the 2017 tax law that Republicans passed, which eliminated tax liability for student debts forgiven for disability or death. This also expires in late 2025. Many experts hope that this will set a precedent for making the forgiveness of all student loans tax-free to become a permanent law.

This removes an obstacle – and nudges Biden

Before the tax correction, some experts believed that the federal government could find some alternative solutions to make forgiveness tax-free, if it wanted to, although there was hardly a general agreement on the matter. Democrats have now closed this part of the broader debate about student debt.

President Biden has been adamant that he is not interested in canceling student debt on his own through executive action and would like Congress to forgive $ 10,000 of the debt. If Congress acted, this new provision would apply. But many Democrats are also using this to urge Biden to act on his own and cancel until $ 50,000 in student loans.

Both Menendez and Warren made it clear, after the Covid-19 relief bill passed, that the goal is to smooth the way for Biden to take action.

The student debt forgiveness debate is not going away, and the pressure on the White House to do something is growing.