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In the $ 1.9 trillion federal stimulus package that is making its way through Congress and likely to be signed into law soon, an important provision has been included that makes any student loan forgiveness tax-free.
Currently, any student loan debt canceled by the government can be considered taxable and taxed at the borrower’s normal income tax rate.
For example, if someone makes $ 50,000 a year, had a 22% tax rate, and received $ 30,000 in student loan forgiveness, they could receive a $ 6,600 bill from the IRS.
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Soon, borrowers can be free of these payments.
What Borrowers Can Save
There are about 45 million student loan borrowers in the US.
One third of these borrowers are enrolled in “income-based repayment plans.” These plans aim to make borrowers’ payments more affordable by limiting their monthly bills to a percentage of their discretionary income and paying off remaining debt after 20 or 25 years. At that point, your forgiven loans are treated as income and the IRS sends the borrower a form called 1099-C.
“It’s like someone giving the borrower money to pay off the debt,” said higher education expert Mark Kantrowitz.
The tax bill can be significant: Let’s say a borrower earns roughly $ 85,000 to $ 160,000, with a tax rate of 24%. If the government canceled $ 48,000 in student debt, they would have to write the IRS a check for $ 11,520, according to an example provided by Kantrowitz.
The Student Loan Tax Relief Act, introduced by Senator Elizabeth Warren, D-Mass. And Senator Bob Menendez, DN.J., and now 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 with income-based repayment plans would be the most affected by the change. Other student debt forgiveness plans, including a popular one for public servants and another that cancels debt for people with severe disabilities, are no longer taxable.
A good sign for debt forgiveness?
Advocates also hope that the tax-free cancellation of student loans will remove a roadblock for President Joe Biden to forgive student debt.
“This will pave the way for President Biden to provide real relief to student borrowers without fear of receiving a huge tax bill that they cannot pay,” said Ashley Harrington, federal director of advocacy for the Center for Responsible Lending, in a statement about the weekend.
Critics of student loan forgiveness argue that it won’t stimulate the economy because college graduates tend to have higher incomes and 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 off their loans or never took them out, while sending the message that it is okay for people to get rid of their debts.
Advocates, meanwhile, say that student loan borrowers were already in crisis before the pandemic, with a third of borrowers in default or in default, and that the pain has only worsened after a year of record unemployment. They also note that it is people of color who bear the brunt of the student loan crisis, and it is also African Americans and Hispanic Americans who have suffered the most economically from the coronavirus pandemic.
Biden says he supports $ 10,000 student loan forgiveness, but is under increasing pressure from members of his own party, advocates and borrowers to go further and write off $ 50,000 per borrower.
If that forgiveness goes tax-free, $ 10,000 in cancellation would save the average borrower about $ 2,000 in taxes, according to a rough estimate by Kantrowitz. If $ 50,000 per borrower were written off, the average person would avoid a $ 10,000 tax bill.