According to the Tax Foundation, a Washington, D.C. nonprofit think tank, borrowers who benefit from President Biden’s student loan forgiveness plan may be subject to taxes in some states as a result of debt forgiveness.
“Under current law, the tax code handles debt forgiveness differently depending on the borrower’s repayment plan – canceling student loan debt would have potentially complicated new tax implications for borrowers” , senior policy analysts at the think tank said in a blog post they wrote in late August. Authors included Garrett Watson, William McBride and Arnav Gurudatt.
Debt forgiveness recipients can get a federal tax pass, but in some cases may be subject to state income tax, analysts said.
“As it stands, it appears most borrowers will be exempt from federal tax on this round of debt forgiveness,” they said. “However, the discharged debt is likely subject to income tax in several states.”
States that appear to be able to forgive a tax loan include Arizona, Connecticut, Hawaii, Idaho, Illinois, Iowa, Kentucky, Massachusetts, Minnesota, Mississippi, New Jersey, New York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin. said the tank.
Biden’s plan wipes up to $10,000 of student loan debt off the books for borrowers who earn less than $125,000 a year (or couples who earn less than $250,000). Pell Grant recipients, meanwhile, would have up to $20,000 in debt erased.
“Under current law, the tax code treats forgiven or forgiven debt as taxable income, with some exceptions,” the Tax Foundation bloggers said. “If a borrower receives debt forgiveness, they are treated as if they had earned additional income in the previous tax year equal to the amount of debt forgiven.”
They took the example of a borrower who has an annual taxable income of $35,000. If this borrower also has a debt of $20,000, which is subsequently cancelled, this amount is allocated to his taxable income. The total ends up being $55,000. “Typically, a borrower receives a 1099-C tax form when the debt is canceled or canceled, which reports the canceled amount as taxable income to the IRS and to the taxpayer,” the Tax Foundation bloggers noted.
When student loans are now forgiven under income-contingent repayment (IDR) plans, the bloggers said, the amounts are generally treated as taxable income. But “forgiveness under the plans is common because the borrower makes monthly payments based on income, which may be less than the amount of interest accrued each month. The borrower’s loan balance under the plan may actually increase over time until the debt is forgiven, which usually happens after 20 or 25 years of one-time payments,” the bloggers wrote.
The American Rescue Plan Act of 2021 “temporarily exempted student loan forgiveness under IDR plans from federal taxation through 2025 on the grounds that [the] the tax burden resulting from treating canceled student debt as income partially undermines debt relief,” the bloggers said.
Recent legislation from Congress, they said, suggested tax could also be exempt in other circumstances when debt is forgiven. For example, the Tax Cuts and Jobs Act of 2017 exempted canceled student loan debt if canceled under the Total and Permanent Disability Release Program. This program erases federal student loan debt when a medical condition prevents a borrower from working.
Another legislative proposal, the Student Tax Relief Act, “would permanently exclude canceled student debt from taxation without changing the tax treatment of lenders,” the blog says.
“Alternatively, the IRS could classify canceled student loans as qualified scholarships, as they did before 1973, making student debt cancellation non-taxable like other types of scholarships,” the group’s authors said. reflection.
“From a tax simplicity perspective, the rules regarding the tax treatment of canceled loans should be consistent and broadly applied, rather than fragmented,” they said.