Student loans

Questions and answers on the law | Student Loan Waivers and Tax Impact | Columns

What is the federal student loan forgiveness policy just announced by President Joe Biden, and what effect does it have on a borrower’s taxes?

The Department of Education will provide up to $20,000 in debt forgiveness to Pell Grant recipients with loans held by the Department of Education, and up to $10,000 in debt forgiveness to non-Pell Grant recipients . Borrowers are eligible if their individual annual income is less than $125,000 ($250,000 for married couples). Pell grants are those based on the financial need of the student.

While relief may be automatic for borrowers whose income information is readily available to the department — either through a FAFSA form or income-based repayment plans — the majority of borrowers will need to apply through an online form. line. Forms will be available in early October and applicants have until December 31 to submit them.

The pause on federal student loan repayments will be extended one last time until December 31. Payments will resume on January 1.

Borrowers who still owe money after forgiveness will have lower payments. Payouts will be capped at 5% of Discretionary Income, a reduction from the current 10%. Loan balances equal to or less than $12,000 will be forgiven after 10 years of one-time payments, a reduction from the current 20-year plan.

People who voluntarily make loan payments since March 2020, when federal payments were suspended, can request a refund for those payments. These individuals should contact their loan servicer to request reimbursement.

What tax impact will debt forgiveness have on borrowers?

Generally, under IRS regulations, a waiver of debt by a qualified lending institution is considered taxable income. This means that the amount given up is considered income. This will cause a borrower to be taxed at the rate applicable to that income, or perhaps raise the borrowing to a higher tax bracket due to the additional reported income.

Under federal tax law, this student debt waiver will not be considered taxable income. The American Rescue Plan Act of 2021 exempts student loan forgiveness from federal tax returns until the end of 2025.

Most states with income tax have their tax codes tied to IRS regulations to define taxable income. Illinois is one of them. As a result, student loan borrowers (or guarantors like Mom and Dad) who are subject to Illinois taxes will not see the amount of the forgiven debt treated as income for Land of Lincoln tax purposes.

However, some states have their own tax provisions for debt cancellation by lenders that are unrelated to federal law. And those states would not be bound by federal regulations.

If a borrower is subject to income tax in those states (Minnesota, Arkansas, Mississippi, North Carolina, and Wisconsin, for example), the borrower may be subject to the income waiver rule in those states. The applicable tax year depends on exactly when the department signals a waiver for a particular borrower.

Student loan forgiveness can not only be an early Christmas present for borrowers, but also a Christmas carol for the Democratic Party in the upcoming midterm elections in November.

For fiscal conservatives, it’s another heavy link in the chain of national debt dragged down by the ghost of Marley.

Brett Kepley is an attorney with Land of Lincoln Legal Aid Inc. Send your questions to The Law Q&A, 302 N. First St., Champaign, IL 61820.

Brett Kepley is an attorney with Land of Lincoln Legal Aid Inc. Send your questions to The Law Q&A, 302 N. First St., Champaign, IL 61820.