rfranca | iStock | Getty Images
A significant provision that makes student loan issuance tax-free has been included in the $ 1.9 trillion coronavirus stimulus package that is running through Congress and likely soon to be incorporated into law.
Currently, any student loan debt canceled by the government can be considered taxable and charged at the borrower's normal income tax rate.
For example, if someone makes $ 50,000 a year, has a 22% tax rate, and receives $ 30,000 in student loan forgiveness, they might be hit with a $ 6,600 bill by the IRS.
More from Personal Finance:
Covid makes it harder to get into a top college
Learn how delaying your studies can affect your future earnings
College can cost up to $ 70,000 a year
Soon borrowers could be excluded from these payments.
What Borrowers Avail To Save
There are around 45 million student loan borrowers in the US.
A third of these borrowers are enrolled in "income-based repayment plans". These plans aim to make borrower payments more affordable by capping their monthly bills to a percentage of their discretionary income and reducing their remaining debt after 20 or 25 years. At this point, their issued loans will be treated as income and the IRS will send the borrower a form called 1099-C.
"It is as if someone gave the borrower money to repay the debt," said Mark Kantrowitz.
The tax burden can be substantial: let's say a borrower makes approximately $ 85,000 to $ 160,000 at a tax rate of 24%. If the government were to let the government cancel debt of $ 48,000, they would have to write a check to the IRS for $ 11,520, as demonstrated by an example from Kantrowitz.
That of Sen. Elizabeth Warren, D-Mass. And Sen. Bob Menendez, D-N.J., Enacted Student Loan Tax Relief Act, which is now part of the incoming stimulus package, would end that policy. A waived student debt would not affect a borrower's tax liability.
The provision would last until 2025 but could be extended or permanent.
Borrowers on income-related repayment plans would be hardest hit by the change. Other student debt cancellation plans, including a popular plan for civil servants and another that cancels debt for people with severe disabilities, are already tax exempt.
A good sign for debt relief?
Proponents also hope that the tax-free cancellation of the student loan removes an obstacle to President Joe Biden's debt relief.
"This will pave the way for President Biden to bring real relief to student borrowers without fear of receiving a huge tax bill they cannot afford," Ashley Harrington, federal prosecutor at the Center for Responsible Lending, said in a statement over the weekend.
Critics of student loan forgiveness claim that it will not boost the economy, as college graduates tend to be higher earners who put their monthly payments into savings and then stop spending. Others say a debt anniversary is unfair to those who have already paid back their loans or never taken out, while sending the message that it is okay for people to get their debt down.
Proponents, meanwhile, say student loan borrowers were already in crisis before the Covid pandemic – a third of borrowers were in default or insolvency – and that the pain only got worse after a year of record unemployment. They also point out that it is people of color who are bearing the brunt of the student loan crisis, and it is also black and Hispanic Americans who have suffered the most financially from the pandemic.
Biden says he supports $ 10,000 student loan forgiveness but is under increasing pressure from members of his own party, lawyers, and borrowers to go further and cancel $ 50,000 per borrower.
If that forgiveness became tax-free, a $ 10,000 cancellation would save the average borrower around $ 2,000 in taxes, according to a rough estimate by Kantrowitz. If $ 50,000 were canceled per borrower, the average person would avoid a $ 10,000 tax burden.
Have you recently applied for rental assistance? When you're ready to discuss your experience for a story, please email me at email@example.com