A tiny provision in the latest stimulus bill could provide a big benefit to student loan borrowers.
Last week, the House approved President Biden’s $1.9 trillion stimulus package. The stimulus bill now heads to the Senate, where it is currently being debated. A tiny provision in this latest stimulus bill could provide a big benefit to student loan borrowers.
The legislation has numerous initiatives to provide financial assistance to broad sectors of the American economy, including $1,400 in direct payments, extended unemployment benefits, housing and nutritional assistance, a new expanded child tax credit, funding for vaccine distribution, and economic aid to state and local governments.
But tucked away in the vast text of the bill is a provision that could provide significant relief to student loan borrowers, and could also pave the way for further relief in the future. This provision would essentially exempt all student loan forgiveness from taxation through the end of 2025.
By way of background, student loan debt cancellation — including partial cancellation — can be treated as taxable “income” to the borrower by federal and state taxing authorities. In other words, the debtor or borrower may have to pay income taxes on the balance of the cancelled debt, as if they “earned” it in income. Borrowers in these situations still often come out ahead in that they would pay significantly less overall by getting their debt cancelled than they otherwise would through its full repayment, even with the tax bill. But because the cancelled debt can be a taxable event, borrowers could owe substantial taxes, which would be due all at once. And if the borrower doesn’t pay immediately by the tax deadline, there can be penalties.
As an example, take a student loan borrower with $60,000 in outstanding debt. Let’s say $40,000 of that debt gets cancelled or waived. If that $40,000 gets taxed as “income,” the actual tax cost to the borrower would depend on a several factors including the tax bracket that the borrower falls into, and whether there is a state income tax. But assuming an overall effective tax rate of 30%, the borrower in this example may have to pay $12,000 in income taxes. This is, of course, less expensive than paying off the $40,000 balance in full, particularly if it would have been paid in installments over time with interest. But coming up with $12,000 all at once could be difficult or impossible for some student loan borrowers.
The IRS does have exemptions that allow borrowers in certain situations to avoid any tax liability on cancelled debt. For example, there is an exemption for borrowers who get their student loans forgiven through Public Service Loan Forgiveness and other profession-based student loan forgiveness programs, and for borrowers who obtain student loan forgiveness due to a disability. Borrowers can also claim insolvency if their total debts exceed their total assets at the time that a debt is cancelled (this often requires that borrowers complete additional paperwork with their tax return).
But other forms of student loan forgiveness — such as loans forgiven under the 20-year or 25-year terms of income-driven repayment plans, and student loans forgiven as part of a negotiated settlement or compromise — are still generally taxable.
The provision of the stimulus bill, if enacted, would change this, at least temporarily. It would exempt all student debt cancellation — whether complete or partial — from federal taxation. And the provision’s language is broad in that it appears to cover all types of student loans including Direct federal loans, federally guaranteed FFEL loans, and private student loans as well.
Perhaps most importantly, the window of coverage to January 1, 2026 means that it also, in theory, would cover any broad student debt cancellation enacted by President Biden or by Congress in the next four years, and would exempt any such cancellation of student debt from taxation. State taxing authorities, however, could still potentially consider student loan forgiveness as taxable.
Student loan borrower advocates and progressive lawmakers have been lobbying the Biden administration to enact broad student debt cancellation through executive action. Biden has indicated that he would prefer that Congress enact student loan relief, including some level of student loan forgiveness for borrowers. Biden has supported $10,000 in student loan forgiveness, but recently came out against $50,000 in student loan forgiveness proposed by Democratic lawmakers and progressive activists.
In the meantime, Biden has extended the current pause on most federal student loan payments, interest, and collections to September 30, 2021. And he has directed the Justice Department to review the legality of cancelling student debt through executive action.
Here’s Everyone Who Wants Biden To Cancel Student Loan Debt (It’s A Big List)
17 State Attorneys General Push Biden To Cancel $50,000 In Student Loans, Adding To Pressure Campaign
Whether Biden Cancels Student Debt Will Depend On These 3 Things
Biden: I Support Cancelling $10,000 In Student Debt And “Eliminating Interest”
Biden Comes Out Against $50,000 In Student Loan Forgiveness – But Supports This Amount, Instead
Could These Student Loan Borrowers Be Excluded From Biden’s Forgiveness?
Can Biden Cancel Private Student Loans? 3 Options
Adam S. Minsky is an advocate, innovator, and entrepreneur who established a unique law practice devoted entirely to assisting student loan borrowers and their families.