Supporters of student debt relief demonstrate in front of the US Supreme Court on June 30, 2023 in Washington, DC
Olivier Douliery | AFP | Getty Images
If you’re expecting debt relief from the latest round of student loan relief, there’s good news: It won’t entail a federal tax bill.
The Biden administration on Friday announced a plan to forgive 804,000 borrowers $39 billion in student debt in the coming weeks. Forgiveness is achieved by establishing so-called earnings-related repayment plans that pay off the remaining student debt after 20 or 25 years of payment, depending on when they borrowed and the type of loan and type of plan. The solution brought eligible borrowers closer to the 20 or 25 year payment deadline.
Under a provision in the 2021 American Rescue Plan, Biden’s $1.9 trillion Covid-19 stimulus package, student loan forgiveness will be federally tax-free through 2025.
“This includes amounts forgiven under income-contingent repayment plans, which previously presented the challenge of being hit by a tax bomb at the end of the payment period,” said Ethan Miller, certified financial planner and founder of Planning for Progress in the Washington, DC area, specializing in student loans.
However, the American Rescue Plan provision only covers federal taxes, and depending on where you live, you may still see a state tax bill for your waived balance. “It’s important to understand how much your taxes might be and when you’d have to pay them,” Miller said.
While the Tax Foundation estimates that seven states could tax student loan forgiveness in August 2022, legislative changes are still possible. “No one wants to be the state that taxes the origination of credit,” Miller added.
Taxation of Future Loan Forgiveness
Whether you qualify for the latest round of student loan forgiveness or anticipate benefiting from a future termination, it’s always important to plan for taxes, said Becca Craig, CFP at Kansas City-based Buckingham Strategic Wealth, Missouri, which also specializes in student loan planning.
While government loan forgiveness has always been tax-free, the current taxation for income-based repayment plans is temporary.
“Under normal circumstances, anything that is forgiven is taxable unless specifically excluded,” said Lee Reams Sr., a registered agent and founder of TaxBuzz.
If you expect future debt relief through an income-contingent payoff plan after 2025, it’s possible you can still minimize future tax liability by switching plans, Craig said.
“I would highly recommend to anyone aged 20-25 [payment] Reich to seek professional advice,” she said. “It’s a fair bit of change and could save you thousands of tax dollars.”
However, according to Reams, there is also a possibility that the provision for tax-exempt student waivers will be expanded.
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