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Student loan forgiveness will not be taxed.
it new position included in $ 1.9 Trillion Stimulus Package that President Biden signed the law into law on Thursday – a big deal for federal student loan borrowers, because currently any student loan debt canceled by the government is treated as income and may be taxed.
Depending on how much debt can be forgiven and what tax category the borrower belongs to, this used to mean a large tax bill from the IRS.
“It’s a huge relief,” says Laurel Taylor, CEO and Founder of FutureFuel.io, a student debt payment platform. “This is so important because I don’t think I have spoken to any borrower who knows that the current handling of forgiven dollars is taxed.”
How much can this save borrowers?
The changes will most affect borrowers with income-oriented repayment plans. Of the 45 million US student loan borrowers, a third participate in income-driven repayment plans.
Think twice before paying federal student loans in 2021. Freezing federal loan payments was expanded until October, so Farnush Torabi, host of the So Money podcast and contributing editor for NextAdvisor, proposes spend your money better this year. Start creating an emergency fund, or pay off your high-interest credit card debt instead.
These types of repayment plans limit borrowers’ monthly bills as a percentage of their discretionary income and will cancel any remaining debt after 20 or 25 years. If a borrower uses an income-driven repayment plan, it is likely because he cannot afford to pay more on his student loans, Taylor says.
Under current law, if a borrower qualifies for the 22% tax category and is forgiven for a $ 100,000 student loan, he could owe $ 22,000 to the IRS. The new regulation will mean that they do not have to pay this tax.
“We call it a tax bomb,” says Taylor. “It’s not uncommon for borrowers to be forgiven $ 100,000, $ 250,000 or $ 50,000 at the end of an income-driven repayment plan,” she says. “I hope that semi-permanent legislation will lead to permanent legislation.”
But this new provision is temporary. It will run until early 2026, but could be extended or permanent, Taylor says. This means that borrowers with income-based repayment plans who end the loan term before January 1, 2026 will not have to pay taxes on any forgiven outstanding amount.
There are other student debt relief plans that are no longer tax deductible, including a plan for borrowers working in the public service, such as nurses and teachers, and another debt relief plan for those with severe disabilities.
One Less Obstacle To Student Loan Forgiveness
Some experts believe that tax breaks on student loans may be the first step towards wider student debt write-offs. Biden has repeatedly stated that he supports $ 10,000 in student loans, but some party members and supporters want to go further and cancel $ 50,000 per borrower.
“It’s great to see Biden support a $ 10,000 forgiveness for all federal borrowers, but there are many issues that need to be addressed with student loan debt,” says Taylor.
Opponents of student loan forgiveness say it will be a massive, misdirected wealth transfer and will fail to stimulate the economy. Others say it would be unfair to past borrowers who have already paid off their loans, and this fosters short-term thinking that does not address the underlying problem: the cost of higher education.
“Loan forgiveness can be good policy if it targets well the people who are struggling to get their loans back,” says Mark Kantrowitz, a specialist in higher education. “He can get congressional support for the forgiveness of the $ 10,000 loan because it’s partly a compromise. It is not “let’s forgive everyone the student loans, even those who are able to pay off their student loans.”
However, proponents of student loan forgiveness say that student loan borrowers have been in crisis for a long time, and this will create financial freedom for millions of borrowers. This is especially important during the COVID-19 pandemic, when many people are struggling financially and unemployment is at an all-time high, they said. They also note that people of color are the hardest hit by the student loan crisis; Brookings Institution data show that college graduates owe an average of $ 7,400 more than their white peers.
If the new law did indeed abolish the $ 10,000 student debt per borrower, in addition to the tax-exempt debt forgiven, the average borrower would save $ 13,400 in interest, according to Taylor’s estimate.
“Before COVID-19, there was very little progress in quickly implementing measures that would make it easier for borrowers,” Taylor says. “I’m glad to see the cravings.”