Yesterday, President Biden announced an executive action to cancel $10,000 of student loans for certain borrowers, $20,000 for Pell Grant recipients. Certainly, this has been and will likely continue to be a hotly debated topic as to the merits of the policy, fairness, the effects on inflation, and whether this will go to and make it through the Supreme Court.
Setting those thoughts aside for the time being, let’s address everyone’s favorite topic: taxes.
Who Qualifies? First, who is eligible for the forgiveness? Individuals with incomes less than $125,000 and marrieds with incomes less than $250,000 will be eligible for up to $10,000 in debt cancellation per borrower, again, $20,000 if you are a Pell Grant recipient.
Student Loan Payments Deferred Through December 2022 & Resume in January 2023 To help with the transition, the Biden administration is pausing student loan payments yet again through December 31, 2022. If your loans have not been fully forgiven under this executive action, expect to begin repayments of your remaining loan balances in January 2023.
Will You Be Taxed? If you receive forgiveness of your student loans, will you incur a tax surprise in April? Thankfully, the answer is no. At least not on your federal tax return (1040).
Legislators anticipated student loan cancellation and addressed the tax consequences in early 2021. Thanks to the American Rescue Plan Act of 2021 (ARPA), Section 9675 clearly excludes from income the discharge of student loans during 2021 through 2025.
The IRS took it one step further and issued Notice 2022-01 instructing lenders and servicers that they should not send out formal informational tax statements (Form 1099-C) reporting the discharge to the IRS as income.
As a side note, under normal circumstances, cancellation of debt, including student loan debt, is considered ordinary income and may be subject to tax, subject to some exceptions. ARPA made an exception for this cancellation.
What About State Taxes? The tax free nature of the forgiveness applies at the federal level but what about state taxes? Some states will automatically conform to the changes brought about by ARPA where others need to update their conformity on an annual basis, whether in full or selectively. Ultimately, it will depend on your state whether or not the forgiveness will be taxable at the state level. Colorado, for example, has rolling conformity and so it’s expected that the forgiveness will not be taxable in Colorado.
Unknowns and Planning Opportunities? Questions still remain as to how income will be determined with regards to the calculation, the specific year, and filing status. The Department of Education issued a press release stating that they will be issuing further details on claiming the relief in the weeks ahead but that many will receive the relief automatically as they already have the necessary information.
If you’re well below or above the income thresholds, then likely not much needs to be done as you either will or won’t receive the cancellation depending on your situation. If they use 2021’s information, again, there may not be many options since that year has been closed out. If 2022’s information is used, then there’s still time before year end and potentially after to plan for reducing your income such as making retirement plan contributions, health savings account (H.S.A.) contributions, and accelerating expenses for business owners and self-employeds, for example.
Questions, comments, concerns? Want to discuss any of this and how it might affect you and your finances? Let’s chat.