COVID tax break could open the door to student loan cancellation


COVID tax break could open the door to student loan cancellation

The college debt cancellation tax break in the COVID-19 relief program signed earlier this month by President Joe Biden has lifted a potential hurdle to student loan debt cancellation: taxes.

The provision will not count any debt forgiveness from December 31, 2020 to January 1, 2026 as income. Under one of the existing remission programs (income-based repayment), the remitted amount is reported to the IRS as income and taxed according to the borrower’s current tax bracket.

Any debt forgiveness would not benefit borrowers if it resulted in an unaffordable tax bill, says Douglas Webber, associate professor of economics at Temple University.

“I see this as one more step towards eliminating what would not just be a big potential inconvenience, but a big public relations problem,” Webber said.

The tax measure was adapted from the Student Loan Tax Relief Act led by Senators Bob Menendez, DN.J., and Elizabeth Warren, D-Mass. On March 6, Warren tweeted: “This paves the way for President Biden to #CancelStudentDebt without imposing thousands of dollars in unexpected taxes on student borrowers.”

Experts say the tax relief measure could do just that.

“Given the context and all the talk about loan cancellation, I think this is probably a nod from Congress to open this door,” said Megan Coval, vice president of policy. and federal relations to the National Association of Student Financial Aid Administrators.

Artem Gulish, senior policy strategist at Georgetown University Center on Education and the Workforce, said the relief program was just the start for student loan borrowers.

“This is the first thing the Biden administration does; there is always potential for forgiveness,” Gulish said.

However, there is still no legislation or decree that answers the big questions of “if”, “how much” or “when” forgiveness might occur.

What your invoice might look like without tax relief

Imagine that no tax break was included in the stimulus package. Hopefully, let’s also look into a crystal ball and say you have $ 10,000 in student loan debt canceled this year. Your income is $ 68,000 (the approximate median in the United States), which means you are in the 22% tax bracket. Next year, when you pay 2021 income taxes, the canceled debt will be taxed at 22% and you owe $ 2,200 on it.

Without the tax break, the pardon could also have pushed you into a higher tax bracket. Suppose you earned $ 85,525 – the top of the 22% tax bracket – and received $ 10,000 in rebate, which moved you to the next tax bracket. Since this is a progressive tax system, you will end up paying 22% on your income, but 24% on that amount which would spill over into the highest tax bracket ($ 2,400 in this example) .

There are additional sacrifices on the lower end of the income spectrum, says Erica Blom, senior research associate at the Urban Institute, a nonprofit research organization. Switching to another tax bracket could result in the loss of credits, such as the earned income tax credit or the child tax credit.

“It could have been as bad or worse than asking someone to shell out an extra $ 1,000 in taxes,” Blom said.

WHERE IS STUDENT LOAN FORGIVENESS

Democratic lawmakers, a group of 17 state attorneys general and consumer rights advocates have all called on Biden to cancel up to $ 50,000 in federal student loans by executive order.

The president said he was supporting a $ 10,000 general rebate for federal student loan borrowers through Congressional action. At a CNN town hall on February 16, he said he was not supporting a $ 50,000 pardon.

Biden and his team wondered if he had the power to call on the Education Department to cancel its debt through executive action. Lawyers argue that a president has this power under the Higher Education Act. However, the Education Ministry released a legal note in January stating that its secretary did not have the authority to grant a pardon.

The 42.9 million federal student loan borrowers who collectively owe the federal government $ 1.57 trillion are expected to receive a comprehensive remission. A $ 10,000 remission would wipe out the debt of 15 million student loan borrowers entirely, according to NerdWallet analysis of federal student loan data.

Neither of the two rebate proposals would likely benefit borrowers with private student loans or those with commercially-held federal family education loan debt, who were excluded from previous relief programs. However, the tax relief for canceled debts could benefit private student loan borrowers whose debts are settled through bankruptcy.

Meanwhile, federal student loan borrowers remain on an interest-free payment hiatus that began on March 13, 2020 and runs through the end of September.

EXISTING FORGIVENESS PLANS AND IMPTS

While there are debt cancellation programs, success rates and tax implications have varied. Public Service Loan Forgiveness offers tax-free debt cancellation for borrowers who are approved (only 2.2% of applicants have been approved so far, according to federal data). Loan amounts canceled as part of the borrower’s defense against repayment – used if you’ve been defrauded by your school – are not taxed. And the disability discount is also not considered taxable income.

Forgiveness is normally imposed for people on an income-based repayment plan, which fixes payments at a portion of your income and cancels the debt after 20 or 25 years. So far, only 32 borrowers have received a discount through these repayment programs, according to March 2021 data obtained by the National Consumer Law Center.

But most borrowers currently enrolled in an income-based repayment plan will not be eligible for the discount until 2035 at the earliest – well past the January 1, 2026 expiration date of the waiver provision. tax in the new relief program. .

Anna Helhoski is a writer at NerdWallet. Email: [email protected] Twitter: @annahelhoski

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