rfranca | iStock | Getty Images
A significant clause that makes any student loan forgiveness tax-free has been included in the $ 1.9 trillion federal stimulus package that is underway in Congress and is likely to be enacted soon.
Currently, any student loan debt canceled by the government can be considered taxable and charged at the borrower’s standard income tax rate.
For example, if someone earns $ 50,000 a year, has a 22% tax rate and receives $ 30,000 in student loan forgiveness, they can receive a $ 6,600 bill from the IRS.
More from Personal Finance:
Covid is making it difficult to enter an important college
See how delaying college can affect your future earnings
College can cost up to $ 70,000 a year
Soon, borrowers can be free of these payments.
What borrowers can save
There are approximately 45 million student loan borrowers in the United States
One third of these borrowers are enrolled in “income-based repayment plans”. These plans aim to make borrowers’ payments more accessible by limiting their monthly bills to a percentage of their discretionary income and canceling any remaining debt after 20 or 25 years. At that point, forgiven loans are treated as revenue and the IRS sends the borrower a form called 1099-C.
“It’s as if someone gives the debtor money to pay the debt,” said higher education expert Mark Kantrowitz.
Tax collection can be significant: let’s say a borrower earns somewhere between $ 85,000 and $ 160,000, falling at a 24% tax rate. If they had $ 48,000 in student debt canceled by the government, they would have to write a check for $ 11,520 to the IRS, according to an example provided by Kantrowitz.
The Student Loan Tax Relief Act, introduced by Senator Elizabeth Warren, D-Mass. And by Senator Bob Menendez, DN.J., and now a part of the incoming stimulus package, would end this policy. Any student debt forgiven would not affect the borrower’s tax liability.
The provision would last until 2025, but could be extended or made permanent.
Borrowers on income-based repayment plans would be most affected by the change. Other student debt relief plans, including one popular for public servants and another that cancels debt for people with severe disabilities, are no longer taxable.
A good sign for debt forgiveness?
Supporters also hope that making the cancellation of student loans tax free will remove an obstacle that prevents President Joe Biden from forgiving student debt.
“This will pave the way for President Biden to provide real relief to student borrowers, without fearing that they will receive a huge bill of taxes they cannot pay,” said Ashley Harrington, federal defense director at the Responsible Lending Center this weekend.
Critics of student loan forgiveness argue that this will cease to stimulate the economy because graduates tend to earn more money, which will put their monthly payments into savings and not spend more. Others say that a debt jubilee is unfair to those who have already paid their loans or never borrowed, while sending the message that it is okay for people to get out of debt.
Supporters, meanwhile, say that student loan borrowers were already in crisis before the pandemic – with one-third of defaulting or defaulting borrowers – and that the pain only got worse after a year of record unemployment. They also point out that it is people of color who bear the brunt of the student loan crisis, and it is also blacks and Hispanic Americans who have suffered the most financially from the coronavirus pandemic.
Biden says he supports the forgiveness of $ 10,000 in student loans, but is under increasing pressure from members of his own party, defenders and borrowers to go further and cancel $ 50,000 per borrower.
If that forgiveness were to become tax-free, $ 10,000 in cancellation would save the average borrower about $ 2,000 in taxes, according to a Kantrowitz rough estimate. If $ 50,000 per borrower were canceled, the average person would avoid a $ 10,000 tax bill.