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Through the end of 2025, no borrowers will pay income taxes on any student debt discharged by the federal government.
A provision in the March 2021 COVID-19 relief package stipulates that any debt forgiven from Dec. 31, 2020, to Jan. 1, 2026, will not count as income. Without the provision in place, the amount forgiven under one of the existing forgiveness programs (income-driven repayment), is reported to the IRS as income and taxed according to the borrower’s current tax bracket.
Any debt forgiveness wouldn’t benefit borrowers if it led to an unaffordable tax bill, says Douglas Webber, associate professor of economics at Temple University.
“I see this as one step closer to eliminating what would be not just a big potential downside, but a big public relations problem,” Webber says.
And it could clear the way for Biden to cancel debt without the side effect of an additional tax burden.
However, it's still unknown “if,” “how much,” or “when” forgiveness could happen.
What your bill could look like without a tax break
Let’s imagine there was no tax break. And we'll also look into a crystal ball and say you have $10,000 of student loan debt forgiven sometime this year. Your household earnings are $68,000 (the approximate median in the U.S.), which means you fall within the 22% tax bracket. When you pay taxes on 2022 income, the forgiven debt would be taxed at 22% and you would owe $2,200 on it.
Without a tax break, forgiveness could also have pushed you into a higher tax bracket. Say you earned $89,075 — the high end of the 22% tax bracket — and had $10,000 forgiven, which pushed you into the next bracket. Since it’s a progressive tax system, you would end up paying 22% on your income, but 24% on that amount that spilled over into the higher tax bracket ($2,400 in this example).
There are additional sacrifices on the lower end of the income spectrum, says Erica Blom, a senior research associate at the Urban Institute, a nonprofit research organization. Sliding into a different tax bracket could result in loss of credits, such as the earned income tax credit or a child tax credit.
"That could have been as bad or worse than asking someone to cough up an additional $1,000 in taxes," Blom says.
Where student loan forgiveness stands
Members of Congress have urged Biden to cancel $50,000 in debt per borrower. But the president has reiterated that if he used his authority for broad loan forgiveness, it would not be for $50,000. He indicated in April 2022 that his administration is looking into some amount of "debt reduction."
The 45.7 million federal student loan borrowers who collectively owe $1.61 trillion to the federal government stand to benefit from blanket forgiveness. Having $10,000 forgiven would wipe out debt entirely for 15.2 million student loan borrowers, according to a NerdWallet analysis of federal student loan data.
It's unlikely forgiveness would benefit borrowers with private student loans. However, the tax relief for forgiven debt could benefit private student loan borrowers whose debts are settled via bankruptcy.
Meanwhile, federal student loan borrowers remain in an interest-free payment pause that began March 13, 2020, and extends through Aug. 31, 2022.
Existing forgiveness plans and taxes
Although there are existing debt cancellation programs, the success rates and tax implications have varied. Public Service Loan Forgiveness offers tax-free debt cancellation for borrowers who are approved. So does borrower defense to repayment — used if you’ve been defrauded by your school — and disability forgiveness.
Forgiveness is normally taxed for those enrolled in an income-driven repayment plan, which sets payments at a portion of your income and forgives debt after 20 or 25 years.
The education department announced a waiver in April 2022 that would retroactively count additional months of repayment toward income-driven repayment forgiveness for borrowers who were steered into forbearance by their servicers. The waiver also includes borrowers who hadn't consolidated in the direct loan program or who made payments on the wrong type of loan.
The Department of Education estimates the waiver will forgive debt for thousands of borrowers and bring 3.6 million borrowers closer to forgiveness. The tax break means any borrowers whose debt is forgiven prior to January 1, 2026 won't face income taxes on the amount discharged.