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The new Covid relief package makes eligible future cancellations of student loan debt tax-free — here's what it means for you

The amount of a student loan that gets forgiven usually counts as taxable income.

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The American Rescue Plan — the $1.9 trillion Covid relief package that President Joe Biden signed into law Thursday — includes myriad provisions to help Americans and their families, including but not limited to a temporary expansion to the Child Tax Credit, a $300 weekly federal boost to unemployment benefits, and stimulus checks of up to $1,400.

One thorny issue that legislators sidestepped when crafting and approving the bill is student loan forgiveness. U.S. borrowers hold more than $1.7 trillion in student loans, and the bill doesn't forgive any of that debt.

It does, however, include a provision that lays the groundwork for future loan forgiveness: Should the federal government decide to cancel student loans between now and 2025, the amount that gets forgiven will be tax-free. It will not be treated as income. And that's a big policy shift.

Forgiven student loan debt normally counts as income

Currently, most student loan debt canceled by the government — like loans for borrowers enrolled in income-driven repayment plans that forgive a certain amount of debt after a certain number of years — can be considered taxable income for the borrower. Depending on the particulars of your tax situation and how much debt was canceled, that taxable income could add hundreds or even thousands of dollars to your tax bill.

Think about it as though someone gave you the lump sum of cash to pay off the remainder of your loan, says Mark Kantrowitz, an expert on higher education.

"Senators Schumer and Warren have been urging President Biden to forgive student loans with a stroke of a pen," Kantrowitz explains. "Even if the president could forgive student loans through executive action, such loan forgiveness would be taxable. So, they probably included this provision to address that limitation of their argument."

Kantrowitz disputes that Biden has the legal authority to unilaterally wipe out student loan debt, but says senators who support such action are preemptively trying to make it easier to roll out.

Watch out for state taxes on forgiven debts, though

There are caveats to beware of in the language in the American Rescue Plan that would make forgiven student loan debt tax-free. To begin, it would only apply to qualifying student loans.

Furthermore, the legislation does not address potential state taxes that borrowers might face on their canceled debt, Kantrowitz warns.

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"Some states do not conform with federal tax law," Kantrowitz explains. "It is possible that student loan forgiveness will be taxable in some states, even if it is tax-free at the federal level."

The question of student loan cancellation will be a hot topic between now and September, when the third moratorium on student loan payments is set to expire. Biden has previously said he favors clearing $10,000 worth of student loan debt per borrower.

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