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Editor’s Note: This post has been updated to reflect President Biden’s signing of the US bailout on March 11, 2021, which makes all student loan forgiveness tax-exempt.
Since President Joe Biden’s first day in office, federal student loan borrowers have been eager to see if and when he will deliver on his campaign pledge to cancel $ 10,000 in loans per borrower as part of his Emergency action plan amid the ongoing pandemic.
Canceling the student loan would ease the financial burden that 42 million borrowers have long faced.
Below, we go into more detail on the current situation of Biden’s student loan cancellation and the tax implications it would have for borrowers.
Biden’s $ 1.9 trillion American rescue plan unveiled at the end of January did not mention the cancellation of student debt, nor would it have included the cancellation of student debt in his latest budget proposal from May 2021.
This is in the wake of his administration who said earlier this year that he supported forgiveness.
In one February 4 tweet by White House Press Secretary Jen Psaki, she said: “The president continues to support the cancellation [sic] of student debt to relieve students and families. Our team is examining if there are any steps he can take through executive action and would welcome the opportunity to sign a bill sent to him by Congress. “
In early April, President Biden asked the US Department of Education if his executive branch gave him the ability to adopt a massive student loan discount without the approval of Congress.
Democratic lawmakers love Chuck Schumer and Elizabeth Warren to have urged Biden at act quickly – even increasing the rebate to $ 50,000 per federal student loan borrower. Without any forgiveness included in its upcoming budget proposal, however, borrowers might not see action taken or a decision made anytime soon.
While student debt cancellation is still unknown, it is important for borrowers to know in advance what the tax implications are of any type of loan cancellation.
On March 11, 2021, Biden enacted the US bailout, which included a provision that any student loan forgiveness is tax-exempt. In the past, however, canceling the loan would have meant a big tax bill.
“In general, when a debt is canceled, a student loan or other, the canceled amount represents taxable income in the year it is canceled”, Steven rossman, CPA and shareholder of Drucker & Scaccetti, a Philadelphia-based accounting firm specializing in taxation, says To select.
Rossman helps us break down a hypothetical example to show how a $ 10,000 federal student loan forgiveness would traditionally have been imposed before Biden’s tax update.
As a federal student loan borrower, you have $ 10,000 of your loans canceled in 2021. This means that $ 10,000 would be added to your taxable income, under what is called “Debt cancellation (COD)” income, and you would likely receive a Form 1099-C for 2021 as documentation.
Then, when you file your 2021 tax return (in April 2022), you will have $ 10,000 to report as COD income. If you are, for example, in the 20% federal tax bracket, this will incur an additional tax of $ 2,000 ($ 10,000 x 20%), which will be due in April 2022 when the 2021 taxes are filed. (Tax rates vary by individual.)
“The good news is that the borrower doesn’t have to repay $ 10,000, but the bad news is that they will owe $ 2,000 in taxes,” Rossman said.
Before Biden enacted the US bailout, there were only certain exceptions that applied as to whether the student loan forgiveness could be imposed or not. Finaid.org says that the discount can be excluded from taxable income if it is conditional on the borrower working for a specific period in a certain profession, such as with Public Service Loan Discount (PSLF). Additional exceptions to taxable canceled debt can be found on the IRS website.
Rossman had speculated before Biden’s tax update that the unprecedented circumstances of the pandemic may have meant that student loan borrowers would see additional exceptions put in place.
“As we saw when canceling Paycheck Protection Program (P3) loans, P3 loans canceled are not taxable for business owners, if the loans are used for qualifying business expenses, ”he said. “Maybe this will set a precedent for the taxation of student loans that are canceled.”
How to prepare for a possible student loan forgiveness now
Because we don’t yet know if Federal Student Loans will be canceled, plan ahead and make sure you have some cash on hand no matter what the outcome.
One option is to start putting money into a high yield savings account which earns interest. the Varo savings account offers an above-average APY, as well as two programs that automatically transfer money from your Varo bank account to your savings account: Save Your Pay, which transfers a percentage of your salary to your savings, and Save Your Change , which rounds your current account transactions to the nearest dollar and transfers the difference to your savings.
Just setting aside $ 20 a week can earn you $ 1,000 a year, which can come in handy if the loan cancellation fails.
Student loan forgiveness in 2021 won’t increase your taxable income, thanks to the latest US bailout that makes all student loan forgiveness tax-exempt.
Keep an eye on Congress negotiating any further coronavirus relief measures over the next few months, and start saving a little bit on every paycheck now so you’re prepared if forgiveness never happens.
Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.