On September 1, 2023, payments will resume on student loans after a 3.5-year hiatus following the pandemic. The reinstatement of payments and interest accrual comes three months after the Supreme Court struck down President Biden’s loan forgiveness plan.
As borrowers focus on their finances to accommodate loan obligations, Congress and the Biden administration concentrate on other ways to restructure a forgiveness plan. Currently, the tax code provides that, in most cases, a debt’s forgiveness or cancellation is taxed as ordinary income.
This article will focus on the disparities in the tax code at the Federal level and the potential tax ramifications upon those with student loans and the family members who guaranteed them.
The Proposed Plan
The pause of servicing student loans began in the Spring of 2020 as an emergency relief measure. In addition to pausing student loan payments, the relief measures included stimulus payments, unemployment compensation increases, and child tax credit enhancements. These relief packages extended to taxpayers surpassed the $6 trillion mark.
While other relief measures phased out as the economy recovered, the pause in student loan payments continued. This continuation rested on the enactment of President Biden’s forgiveness plan. Now, Congress and the administration are back in the planning stages as borrowers’ obligations are reinstated.
Let’s be clear—President Biden’s plan would have forgiven $10,000-$20,000 for borrowers earning less than $125,000 ($250,000 for those married filing jointly). Complete forgiveness would not have pertained to all borrowers.
A Broader Tax Policy
The issue of student loans remains in purgatory, continues the political debate, and brings the need for a broader tax policy to the surface. All of thisis against the backdrop of the national deficit. Any forgiveness plan will increase the deficit. An unintended consequence could set theprecedent for debt cancellations in the future.
One can only guess if this will incentivize future students to take on more debt with the expectation of forgiveness. This will lead to a larger national deficit and rising inflation.
The Generous Rules
The forgiveness plan was struck down; however, President Biden expanded the income-driven repayment (IDR) options in the loan structure. These rules will come into effect on July 1, 2024.
These repayment options will elevate the percentage above the federal poverty level to 225% and reduce the minimum payment to 5% of discretionary income. Payments on student loans will not begin until a borrower’s financial positionexceeds these levels.
The result will leave many borrowers with an outstanding balance at the end of their loan. The balance could be automatically forgiven after 20-25 years of timely payments. This forgiveness will increase the number of borrowers facing an increased tax liability on their canceled balances.
The current tax law (with narrow exceptions) considers all canceled or forgiven debt as taxable income. In contrast, the American Rescue Plan Act of 2021 exempts forgiven student loanswith IDR plans from federal taxation through 2025. Not every loan is structured under an IDR plan. So, debt forgiveness exempt from federal taxes will not pertain to all borrowers.
Then, there is the issue of student debt associated with closed schools. The US Treasury, of which the IRS is the collection and enforcement arm, has been looking to implement a plan on how to treat the forgiveness of student loans associated with closed colleges.
Should this debt cancellation be considered taxable income as well?
Under the current system, borrowers must claim a forgiven debt as taxable income, while lenders deduct the cost of such forgiveness from their taxable income. The shift in the tax liability from the lenders to the borrowers creates symmetry in the system.
Need Help to Secure Tax Debt Relief? Contact Anderson Bradshaw Tax Consultants Today
The disparities facing Congress and the Biden administration run deeper than forgiving student debt. Any plan of forgiveness will have the most impact on the taxpayers. Borrowers may not be able to pay their increased tax liability as the tax liability of the lenders decreases from the reduced taxable income.
All of this can translate to a higher national deficit. What may be fair to some will not be fair to others.
The expert tax professionals and consultants at Anderson Bradshaw Tax Consulting can help with any tax situation. With over 32 years of experience in the industry, we have seen almost every tax issue and have learned the best ways to handle each situation. You can feel confident knowing your difficulties with the IRS can be resolved and corrected quickly and efficiently at Anderson Bradshaw. Call (877) 550-3911 for a free tax consultation today!