Biden’s new student loan forgiveness changes could end up costing some borrowers

The Biden administration is in the process of implementing significant new federal student loan forgiveness initiatives. These programs could ultimately help millions of borrowers get closer to canceling their student loans.

But depending on the specific program and the exact timing of that loan forgiveness, some borrowers may end up with a surprise penalty: additional taxes.

Biden makes big changes to major student loan forgiveness and repayment programs

In April, the Biden administration announced historic reforms to federal Student Loan Income-Based Repayment (IDR) programs, which include Income-Based Repayment (IBR), revised Pay-as-You-Go win (REPAY) and other plans. IDR plans allow federal borrowers to make payments based on their income and family size. After 20 or 25 years in the program (depending on the specific plan), any remaining balance may be forfeited.

IDR plans have also been a mandatory part of the Public Service Loan Forgiveness Program (PSLF), which can eliminate federal student loan debt for borrowers in as little as 10 years if they work full-time for government agencies or non-profit organizations. Last October, the Biden administration also announced sweeping, temporary changes to the PSLF program, called the “Limited PSLF Waiver” initiative.

Taken together, the PSLF’s limited exemption program and the temporary changes to the IDR, which the administration calls the “IDR adjustment,” will allow the Department of Education to count significantly more loan for student loan cancellation under IDR and PSLF, including:

  • Any past period during which the Borrower was in a “repayment state”, regardless of the type of repayment plan or the details of a particular payment;
  • 12 or more prior months of consecutive abstention, or 36 or more months of cumulative abstention;
  • All previous months spent in deferment (with the exception of school deferment) before 2013; and
  • Repayment deadlines prior to the consolidation of credits.

According to the Ministry of Education, “Any borrower whose loans have accrued repayment time of at least 20 or 25 years will see automatic forgiveness, even if you are not currently on an IDR plan.” The Department estimates that 40,000 borrowers could get loan forgiveness very quickly, while millions more borrowers could progress to eventual student loan forgiveness.

Some borrowers may be taxed on student loan forgiveness

Generally, any time a debt (including a student loan) is reduced, forgiven, canceled, or canceled, the debtor or borrower may have to pay taxes on that canceled balance. The lender would send the borrower a Form 1099-C during the tax period, which would show the amount of the loan forgiveness. The borrower may then have to report the canceled debt on their tax return as “income”, resulting in increased taxes. When large amounts of debt are forgiven, it can result in significant tax liability for the borrower.

Some types of student loan forgiveness are not taxable. The Public Service Loan Forgiveness (PSLF) is not taxable under federal law, and the same is true for relief under the PSLF Limited Waiver. Thus, borrowers who would obtain student loan forgiveness under this program would not have to worry about federal taxation.

However, loan forgiveness under the IDR is more complicated. This type of student loan forgiveness is generally taxable. However, the American Rescue Plan Act — the stimulus bill passed by Congress and signed into law by President Biden last year — temporarily exempts all federal student loan forgiveness from federal tax until the end of 2025. This means for borrowers who expect immediate or imminent student loan forgiveness. as a result of the new IDR adjustment, they should not have to pay federal income tax.

“The US Bailout Act included a provision temporarily changing the tax treatment of discharged student loan debt,” the Department of Education says in published guidance. “Specifically, the law excludes from gross income eligible student loans that are discharged between December 31, 2020 and January 1, 2026. During this period, amounts of canceled student loan debt will not be subject to tax. “

But borrowers who are able to gain years of progress toward loan forgiveness under the IDR adjustment, but still have some time left to repay, could find themselves facing a bill of unexpected tax much sooner than they anticipated. For example, a borrower on a 25-year term who goes from five years of progress toward IDR loan cancellation to 21 years of progress toward loan cancellation under the IDR adjustment may obtain cancellation of his loan in just four years, instead of another 20 years. . But that loan forgiveness would fall outside the tax-exempt window under the American Rescue Plan Act, potentially subjecting them to significant tax liability in 2026.

A $100,000 student loan forgiveness could result in a tax bill of $25,000 to $30,000, depending on the borrower’s federal tax bracket and other potential tax exemptions or deductions.

Biden pushes Congress to make student loan forgiveness tax exemption permanent

There are certain exemptions under the existing tax code that may allow some borrowers facing early student loan forgiveness under the IDR to avoid taxation. For example, a borrower who is insolvent at the time a debt is forgiven (i.e. the value of their debts exceeds the value of their assets) may be able to reduce or even eliminate the tax bill resulting. But it would depend on the specific financial condition of the borrower.

In March, President Biden included a provision in his budget proposal that would make federal student loan forgiveness under the IDR permanently tax-exempt. But it would ultimately be up to Congress to pass it, and it’s far too soon to know whether Congress would include a permanent solution to the student loan relief issue in final budget legislation.

Further Reading on Student Loans

If Biden enacts a broad student loan waiver, it could look like this

Pausing student loan payments: Biden official says repayment will resume ‘at some point’ — here’s what that could mean

Want student loan forgiveness? To qualify, borrowers may need to do this first

Who qualifies for student loan relief under Biden’s huge new income-based repayment expansion

Comments are closed.