Federal student loan debtors have been waiting anxiously since President Joe Biden’s first day in office to find out if and when he will fulfill his campaign promise to cancel $10,000 of loans per borrower as part of his Emergency Action Plan despite the ongoing pandemic. On August 24, 2022, he signed a law canceling up to $20,000 in federal college loans for every borrower.
How does this affect your taxes next year? The tax ramifications of President Biden’s massive student loan forgiveness plan are discussed in greater detail below.
Where do things stand with Biden’s Plan to Forgive Student Loans?
Millions of debtors will have their federal student loans forgiven on August 24, 2022, thanks to an announcement made by President Biden. Borrowers that qualify have annual incomes of less than $125,000 for individuals or $250,000 for families.
Pell Grant winners might have their student loans forgiven up to $20,000.
Most non-Pell borrowers can have up to $10,000 in student debt forgiven
Those who still owe money on their federal student loans after the forgiveness has been applied will not have to start paying them back until the first of the year 2023. This is because forbearance (the repayment freeze) has been extended until the end of 2022.
The income-based repayment plan for undergraduate loans will also be updated as part of these measures. Payments for those on income-based repayment plans are being lowered from 10% of monthly income to 5% of income, among other changes.
Private student debts are unaffected by loan forgiveness or forbearance. If you have private student loans, you may want to consider refinancing with a company like SoFi or Laurel Road in order to lower your interest rate and improve your repayment conditions.
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Impact on Tax Payments from Biden’s Plan to Cancel Student Loans
Biden made it a law that all forgiven student loans are not subject to taxes in March 2021, when he signed the American Rescue Plan.
Although you might not have to pay federal income taxes on forgiven student loans, you might have to pay state income taxes on the amount of debt that was forgiven. If that’s the case, it could be wise to start setting aside funds now for when tax time rolls around.
Nonetheless, debt cancellation is often subject to taxation. Forgiven debt, whether from student loans or otherwise, is considered taxable income in the year it is written off, according to Steven Rossman, CPA, shareholder at Philadelphia’s tax-focused accounting firm Drucker & Scaccetti, who spoke with Select.
Rossman demonstrates how a federal student loan forgiveness of $10,000 would have been taxed prior to Biden’s tax reform proposal.
Let’s pretend that in 2022, as a federal student loan borrower, $10,000 of your loans are forgiven. As a result, you would need to include $10,000 in your 2021 tax return as “Cancellation of Debt (COD) income,” and you would likely get a Form 1099-C to prove it.
In that case, you’ll have $10,000 in COD income to declare when you file your tax return for 2022 (in April 2023). The additional tax of $2,000 ($10,000 x 20%) would be required in April of 2023, along with your 2022 tax return, if, for instance, you are in the 20% federal tax bracket. (Taxes will be different for each person.)
The borrower “would owe $2,000 in taxes,” but “the good news is that they don’t have to pay back $10,000,” adds Rossman.
When Tax-free Forgiveness of Student Loans is available?
Student loan forgiveness was subject to taxation with few exclusions before Biden signed the American Rescue Plan into law. Forgiveness that is tied to the borrower’s employment in a specified field, such as Public Service Loan Forgiveness, may be exempt from income tax, according to Finaid.org (PSLF). You can find other exemptions from taxation of the forgiven debt on the IRS website.
Prior to Biden’s tax update, Rossman had hypothesized that the unusual nature of the epidemic would have led to the establishment of extra exceptions for student loan debtors.
Paycheck Protection Program (PPP) loan forgiveness is not taxable to business owners if the money is put towards legitimate company expenses, he explains. Perhaps this will serve as an example of how to handle the taxation of discharged student debt.
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