College tuition in America has risen steadily every year, with the cost more than doubling in the last two decades. As such, it’s unsurprising that U.S. News pegs the average student loan debt for Americans at approximately $30,000. So when President Biden recently announced a new student loan forgiveness program, college graduates rejoiced.
But here’s the question on everyone’s minds: Will student loan forgiveness be taxable? We’ve got all the answers right here about the new student loan forgiveness program and what it will mean for those young Americans shouldering massive college debt.
Sometimes, creditors will reduce, waive, forgive, or cancel a borrower’s debt. However, there’s a catch: That borrower may have to pay income taxes on the debt as if it were regular income. When this occurs, the creditor sends the borrower a 1099-C Form that requires them to report the canceled debt as income on their return.
The new student loan debt relief program will cancel up to $10,000 in debt if a single filer earns under $125,000 a year ($250,000 for married couples). Pell Grant borrowers are eligible for up to $20,000 in forgiveness. In addition, Biden and the U.S. Congress recently passed the American Rescue Plan, which exempts all federal student loan forgiveness from typical income taxation until 2025.
According to federal law, certain forms of student loan forgiveness are eligible for tax exemption. Therefore, you won’t have to pay federal income taxes on any debt forgiveness through the new student loan forgiveness plan as long as it occurs before January 1, 2026. However, without this new provision, any forgiven debt that applies under an existing repayment program would require mandatory IRS reporting and taxation according to the individual’s tax bracket.
While Biden’s student loan forgiveness program doesn’t allow for debt taxation on the federal level, the state level is a little trickier. For example, certain U.S. state laws allow the taxation of borrowers with canceled or forgiven debt as part of their state income tax. Therefore, those states may tax residents who have applied to the student loan forgiveness program to reduce their debt.
Residents of the following states are likely to face this taxation on their tax bills:
In addition, these are states where residents could be subject to this debt taxation, although it’s not definite:
However, some states are taking action to avoid this type of debt taxation through legislative or administrative avenues. For example, the Paycheck Protection Program (PPP) caused similar issues when it provided loan forgiveness funds to small businesses during the pandemic.
When this happened, some states passed legislation to transform state tax law into federal tax law for a short period to prevent state debt taxation. Therefore, this may also occur regarding Biden’s new student loan forgiveness program.
So, what’s the takeaway: Will student loan forgiveness be taxable? On the federal level, the answer is no, although some states may permit the taxation of forgiven debt. However, this program is new, and only time will tell how each U.S. state will react to the issue of debt taxation.
If you need help with tax resolution we can help. At Levy & Associates, our financial experts and tax professionals help hard-working Americans just like you every day with their tax problems. Call Levy & Associates today at 1(800) TAX-LEVY and schedule your free consultation with our team.
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