Student loan debt forgiveness can come with a tax bill

Since President Biden decided to forgive student loan debt for some Americans, Bridget Jeffart and her husband say they likely won’t be able to enjoy their usual tax refund because they’ll have to pay state taxes on the debt relief their.

Gephart borrowed $45,000 to get her undergraduate and graduate degrees. “The total right now is up to $80,000 because it’s accruing $8,000 in interest every year even though I’m making payments,” Gephart said.

Gephart and her husband qualify for $20,000 in student debt relief under Biden’s executive action, but as Indiana residents, they will have to pay taxes on it. “Our entire federal tax refund will go to pay this Indiana state tax now that we would have previously used to pay for the kids,” Gephart told Yahoo News.

President Biden announces student loan relief with Education Secretary Miguel Cardona, right, on August 24 at the White House in Washington, DC (Olivier Douliery/AFP via Getty Images)

With their twin boys, the Gepharts, like many Americans, have struggled with student debt. “Like, even though we’ve worked really hard, I just feel like I can’t go forward,” he said.

According to the Student Debt Crisis Center, Americans owe more than $1.5 trillion in student debt — more than credit card debt and car loan debt combined.

To help relieve borrowers, Biden announced last month that he would cancel $10,000 in student loan debt for borrowers making less than $125,000 a year. Pell Grant recipients will be eligible for an additional $10,000 in forgiveness.

Biden said 95 percent of borrowers, or about 43 million people, would benefit from the relief — but that some would have to pay taxes on it. “That’s because historically, at both the federal and state levels, any kind of debt relief or debt cancellation is actually taxable income,” Jared Walczak, vice president of government projects at the Tax Foundation, told Yahoo News.

However, to avoid federal taxation of borrowers, the administration has decided that any student loan debt forgiveness will not be taxed from 2021 to 2025, according to a provision of the 2021 American Rescue Plan.

“Some states are following [the provision made under the American Rescue Plan]In fact, most do. But there are some states that don’t fully comply with the federal code or comply with this provision, and therefore, they will tax student loan debt relief,” Walczak said.

The Tax Foundation's Jared Walczak on the mic.

Jared Walczak of the Tax Foundation addresses a hearing of the Legislative Tax Study Committee on Capitol Hill in Jackson, Miss., on August 25. (Rogelio V. Solis/AP Photo)

Currently, some states plan to tax student loan debt forgiveness. Walczak said that for many of these states, it’s just an accident. “They’re basically following the old standard tax write-off practice and not including the new federal provision that says it’s an exemption,” he explained.

At least seven states plan to tax student loan debt forgiveness, including Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina and Wisconsin. More than 8 million federal student loan borrowers live in one of the states that will tax debt relief, according to federal data from March 2022.

The Tax Foundation predicts that the average American will owe about $500 on a $10,000 student loan and $1,000 on a $20,000 student loan forgiveness. But, “for most borrowers, if you get $10,000 in loan forgiveness and pay $500, it’s still a deal you’re going to make,” Walczak said.

Cody Hounanian, the executive director of the Student Debt Crisis Center, has been on the front lines pushing for student debt forgiveness for years.

Although some states will tax debt cancellation, Hounanian told Yahoo News that this relief is a win for borrowers. “It will change the lives of tens of millions of Americans. I mean, 40 million Americans will have some student debt canceled, 20 million will see their debt completely wiped out, that’s a huge first step,” he said.

But Hunanian says this victory is just the beginning, explaining “If we have to focus our attention on state governments to try to prevent unnecessary taxes, we will do that too. The fight goes on.”

Mortar students line up to receive their degrees.

Students in academic gowns attend their graduation ceremony at the University of California, Los Angeles on June 14, 2019. (Robyn Beck/AFP via Getty Images)

Now, the Student Debt Crisis Center is working with advocates and policymakers to repeal state taxes for student debt relief, but states must move quickly if they want to change their policies.

“There’s a narrow window for them to act in the states,” Walczak explained. “The Legislature is not in session at present, they will all come next January. But they have a narrow window because people start filing their tax returns quite early. Each of these states, like the federal government, has an April 15 deadline, but many people apply before then. So if there is going to be action, it needs to be done very quickly.”

Walczak said the Tax Foundation is pushing for borrowers to prepare. “You have to recognize that this could happen, at least in some states, and you have to be on top of it,” he said.

Most importantly, tax experts suggest that borrowers planning to receive relief should pay attention to the details because the relief plan and its effects are complex. Walczak says many borrowers in states that tax debt relief may not report it as income, “because it’s not necessarily clear.”

“When you go to file your state taxes,” he added, “there won’t be a line that says federal student loan debt forgiveness. You have to know to include it in your income. That’s where tax preparers come in.” . This is where close reading comes into play.”

For Gephart, a firstGeneration college graduate, paying taxes to erase debt will be a challenge. “We believe that no borrower who receives student debt forgiveness should be taxed by state or local governments. And, frankly, we’re going to work very hard to make sure that’s the case,” Hunanian said.

Leave a Reply

Your email address will not be published. Required fields are marked *