Student loan issuance will be tax free.
It’s a new provision included in the $ 1.9 trillion stimulus package that President Biden signed on Thursday – and a big deal for federal student loan borrowers, as all student loan debt canceled by the government is currently considered Income can be treated and taxed.
Depending on how much debt can be canceled and what tax bracket a borrower falls into, this used to mean a high tax bill from the Internal Revenue Service.
“It’s a huge relief,” said Laurel Taylor, CEO and founder of FutureFuel.io, a student debt repayment platform. “This is so important because I don’t think I’ve spoken to a single borrower who is aware that the current treatment of the dollars given is taxed.”
How much could borrowers save as a result?
Borrowers in income-oriented repayment plans will be hardest hit by the change. Of 45 million student loan borrowers in the United States, one-third are involved in income-based repayment plans.
Think twice before paying off your federal student loan in 2021. Freezing payments on federal loans was extended until October, says Farnoosh Torabi, moderator of the podcast “So Money” and editor at NextAdvisor, suggests spend your money better this year. Instead, build an emergency fund or pay off high-interest credit card debt.
These types of repayment plans limit borrowers’ monthly bills to a percentage of their disposable income and cancel their remaining debts after 20 or 25 years. If a borrower has an income-oriented repayment plan, it’s likely because they can’t afford to pay more for their student loans, Taylor says.
If a borrower falls into the 22% tax bracket under applicable law and is waived a $ 100,000 student loan, they can owe the IRS $ 22,000. The new rule would mean that they would not have to pay this tax.
“We call it the tax bomb,” says Taylor. “It’s not uncommon for borrowers to be waived $ 100,000, $ 250,000, or $ 50,000 at the end of an income-driven repayment plan,” she says. “I am confident that the semi-permanent legislation will lead to permanent legislation.”
But this new destination is temporary. It would last through early 2026 but could be extended or permanent, Taylor says. This means that borrowers with income-oriented repayment plans who end their loan term between now and January 1, 2026 will not have to pay taxes on outstanding amounts that have been waived.
There are other student debt relief plans that are already tax-free, including one for borrowers who work in the public sector – such as nurses and teachers – and another that provides debt relief for people with severe disabilities.
One less obstacle to student loan forgiveness
Some experts say student loan tax breaks could be the first step in widening student debt cancellation. Biden has repeatedly said that he supports the $ 10,000 student loan award, but some of his party members and supporters want to go further and cancel $ 50,000 per borrower.
“It’s exciting to see Biden support the $ 10,000 waiver for all federal borrowers, but there are many issues that need to be resolved with student loan debt,” said Taylor.
Opponents of the student loan waiver say it would be a large, misdirected wealth transfer and it would not boost the economy. Others say it would be unfair to previous borrowers who have already paid off their loans, and it encourages short-term thinking that doesn’t address the underlying problem: the cost of higher education.
“Lending can be a good policy if it’s targeted at people who are having trouble paying back their loans,” says Mark Kantrowitz, a college expert. “He could get Congressional support for the $ 10,000 lending because it’s in part a compromise. It does not mean, ‘Let us forgive everyone who has student loans, including those who are able to repay their student loans.’ “
However, advocates of student loan waivers say that student loan borrowers have long been in crisis and that this would give millions of borrowers financial freedom. This is especially important, they say, during the COVID-19 pandemic, when many people are struggling financially and unemployment is at a record high. They also point out that it is the colored people who are suffering the most from the student loan crisis; Brookings Institute data shows that black college graduates owe an average of $ 7,400 more than their white counterparts.
According to Taylor estimates, if a new law waives $ 10,000 student debt per borrower, the average borrower will save $ 13,400 in interest in addition to being non-taxable on canceled debts.
“Prior to COVID-19, there was very little progress in quickly adopting measures to provide borrower relief,” said Taylor. “I am encouraged to see the traction.”