If $10,000 vanishes from your student debt, you may want to celebrate.
But what does that mean for the rest of your financial life?
This is a question millions of student loan holders are facing on Wednesday after President Joe Biden proceeded with a controversial plan to cancel $10,000 in federal student-loan debt per borrower earning less than $125,000 per year.
The Biden administration will cancel an additional $10,000 for those receiving Pell Grants.
The administration also announced it would extend the pause on student loan payments, collections and interest, through December 31. The freeze was scheduled to expire on August 31.
“The American Rescue Plan exempted student-loan cancellation from paying federal tax on that forgiveness through 2026. ”
The March 2021 American Rescue Plan changed that, exempting student-loan cancellation from federal cancellation of debt tax provisions through 2026. Democratic lawmakers were thinking ahead about the chance of loan cancellation and preventing student-loan debt from becoming tax debt, Chingos said. “The goal of that change was to take this problem off the table,” he said.
It makes no difference for tax purposes if the student-loan debt is cancelled through executive action or a Congressional law change, Chingos said. Without the tax provisions, a borrower making at least $122,000 a year would have faced an extra $2,400 in federal taxes, according to Chingos’ research. Someone earning less than $25,000 a year would have faced an extra $800 in federal income taxes, the calculations showed.
But borrowers in some places might face state-level income taxes for the debt cancellation, according to Susan Allen, senior manager of tax practice and ethics at the American Institute of CPAs.
Tax laws in approximately 20 states would follow federal law when it comes to the tax treatment of student debt cancellation, Allen said. Connecticut and Maryland are two examples. But the tax laws in roughly 15 states, including New Jersey and Mississippi, have potentially open questions on the issue, she added.
That’s where it’s important to do homework or check with a tax professional, Allen said. “Each state would have different nuances to check out.”