Student loan cancellation is now tax free

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The cancellation of the student loan will be tax free.

This is a new provision included in the $ 1.9 trillion stimulus package President Biden enacted on Thursday – and a big deal for federal student loan borrowers because, currently, all student loan debt. canceled by the government is treated as income and may be taxed.

Depending on how much debt can be written off and what tax bracket a borrower is in, this previously meant a hefty tax bill from the Internal Revenue Service.

“It’s a huge relief,” says Laurel Taylor, CEO and founder of FutureFuel.io, a student debt repayment platform. “This is so important, because I don’t think I have spoken to a single borrower who knows that the current treatment of dollars that are written off is taxed.”

How much could this save borrowers?

Borrowers with income-based repayment plans will be the most affected by the change. Out of 45 million student loan borrowers in the United States, one-third are enrolled in income-tested repayment plans.

Pro tip

Think twice before paying off your federal student loans in 2021. Freezing Federal Loan Payments has been extended until October, so Farnoosh Torabi, host of the “So Money” podcast and collaborating editor at NextAdvisor, suggests make better use of your money this year. Start building an emergency fund or pay off high interest credit card debt instead.

These types of repayment plans cap borrowers’ monthly bills at a percentage of their discretionary income and write off any remaining debt after 20 or 25 years. If a borrower benefits from an income-based repayment plan, it’s likely because they can’t afford to pay more for their student loans, Taylor says.

Under current law, if a borrower falls into the 22% tax bracket and their student loan is canceled by $ 100,000, they may owe the IRS $ 22,000. The new provision would mean that they do not have to pay this tax.

“We call it the tax bomb,” Taylor says. “It’s not unusual for borrowers to have $ 100,000, $ 250,000, $ 50,000 returned at the end of an income-based repayment plan,” she says. “I hope that semi-permanent legislation will lead to permanent legislation.”

But this new provision is temporary. It would last until early 2026, but could be extended or become permanent, Taylor says. This means borrowers on income-driven repayment plans who end their loan term by January 1, 2026 will not have to pay taxes on any overdue amounts canceled.

There are other student debt cancellation plans that are already tax-free, including one for borrowers who work in the public service, like nurses and teachers, and one that cancels debt for people with severe disabilities. .

One less obstacle to canceling a student loan

Some experts say student loan tax relief could be the first step towards broader student debt cancellation. Biden has repeatedly said he supports canceling $ 10,000 in student loans, but some in his party and supporters want to go further and write off $ 50,000 per borrower.

“It’s exciting to see Biden supporting a $ 10,000 rebate for all federal borrowers, but there are a lot of issues to be resolved with regard to student loan debt,” Taylor said.

Opponents of the cancellation of student loans say it would be a large and misdirected transfer of wealth and not stimulate the economy. Others say it would be unfair to former 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.

“Loan cancellation can be a good policy if it is well targeted to people who are struggling to repay their loans,” says Mark Kantrowitz, a higher education expert. “He could get congressional support on the $ 10,000 loan cancellation because part of it is a compromise. It is not, “let’s forgive everyone for student loans, even those who are able to repay their student loans”.

However, supporters of student loan cancellation claim that student loan borrowers have been in crisis for a long time and it would create financial freedom for millions of borrowers. This is especially important, they say, during the COVID-19 pandemic, when many people are struggling financially and unemployment is at an all time high. They also point out that it is people of color 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 peers.

If a new law cancels $ 10,000 in student debt per borrower, in addition to the forgiven non-taxable debt, the average borrower will save $ 13,400 in interest, according to a Taylor estimate.

“Before COVID-19, there was very little progress in quickly introducing measures that provide relief to borrowers,” Taylor said. “I’m encouraged to see the pull. “

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