Student loan forgiveness becomes tax-free under COVID relief bill

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$5 Billion In Student Loan Debt Could Be Forgiven. Is Your Debt Part Of It?

Student Loan Tax Relief Act ends tax liability for borrowers with unpaid balances

Student loan debt that is canceled before the full balance is paid off became tax-free under a provision in the $1.9 trillion coronavirus stimulus package.

Formerly, any student loan debt canceled by the government was considered taxable and levied at the borrower’s normal income tax rate.

»RELATED: Biden rejects proposal to cancel $50,000 in student loan debt

Proponents of the measure say the legislation — known as The Student Loan Tax Relief Act — creates a new path for President Joe Biden to wipe away hundreds of millions of dollars in student loan debt as congressional Democrats continue to apply pressure on the issue.

“This will pave the way for President Biden to provide real relief to student borrowers without fearing they’ll receive a huge tax bill they cannot afford,” said Ashley Harrington, federal advocacy director at the Center for Responsible Lending, according to CNBC.

About one-third of the 45 million student loan borrowers in the United States are enrolled in “income-driven repayment plans,” which caps monthly payments at a portion of discretionary income, and which ultimately cancels any remaining unpaid balances after 20 or so years.

To the IRS, the unpaid balance on the loan was considered income, and the agency lets the borrower know by mailing form 1099-C.

And the amount of the tax bill can be shocking.

Under previous standards, a person earning $50,000 in annual salary, and paying 22% in taxes, would face a potential $6,600 tax bill if the individual received $30,000 in student loan forgiveness, according to CNBC.

For a borrower earning between $85,000 and $160,000 at a 24% tax rate, $48,000 in student debt forgiveness would amount to a tax bill of $11,520, according to higher education expert Mark Kantrowitz.

“It’s as if someone gave money to the borrower to repay the debt,” said Kantrowitz, according to CNBC.

The Student Loan Tax Relief Act, sponsored by Democratic Sens. Elizabeth Warren of Massachusetts and Bob Menendez of New Jersey, ended the policy of taxing this type of loan forgiveness through at least 2025, with the possibility of becoming permanent law thereafter.

Student loan debt forgiveness plans for those who enter public service and for people with serious disabilities are already nontaxable.

Biden previously said he supports the idea of forgiving $10,000 per borrower but also has expressed reservations about doing it unilaterally through executive action.

The president also said he would support making community college free and for allowing families who earn $125,000 or less to send their children to state schools for free. He also said he supports eliminating interest payments and expanding debt forgiveness programs for Americans who take public service jobs, such as teaching.

Biden, however, stopped short of saying he would sign an executive order forgiving $50,000 in student loan debt for millions of Americans as congressional Democrats continue to pressure the White House for additional relief for struggling families amid the coronavirus pandemic.

The resolution calling for $50,000 in debt relief was introduced in February by Warren and Senate Majority Leader Chuck Schumer of New York.

Such a move would have cost about $800 billion and deliver 36 million Americans out of debt, according to reports.

The Higher Education Act of 1965 authorizes the U.S. secretary of education to cancel student loans, meaning Biden could order the move, according to Warren and Schumer’s provision. However, Biden didn’t have an appetite for such a unilateral move considering the stakes of hundreds of billions of dollars that would need to be wiped off the books all at once for nearly 40 million people.

“Canceling student loan debt is the single most effective executive action President Biden can take to lift the economic prospects of tens of millions of young Americans,” Warren said recently.

All federally backed student loans have been in forbearance throughout the pandemic, and Biden extended the pause in payments and interest until Oct. 1.

Supporters of the loan cancellation plan say it would spark a wide swath of the economy, including new business, consumer spending, retirement savings, homebuying and other sectors. Critics, however, say the move would only bring a modest bump to economic activity in GDP. Republicans reportedly oppose the move.

The White House has continued to signal that Congress should pass legislation to achieve it as student loan matters typically fall under federal spending set by Congress.