Forgiveness Of Student Loans Taxable

Last Updated on January 19, 2023

Forgiveness Of Student Loans Taxable

If you have student loans and your lender forgives your debt in a manner that qualifies as a gift, the amount of the canceled debt is considered income for tax purposes. If the cancellation is due to a discharge on account of total and permanent disability (TPD), it is not taxable. However, if the cancellation occurs because the borrower has been unable to make payments because of any other reason, the forgiven debt is treated as taxable income.

Income tax laws require that all individuals report all of their income on their yearly tax form. This includes any money received from employers, investments or even any gifts received from others. The IRS requires that taxpayers include all forms of income when calculating their total taxable income for the year so they can pay taxes accordingly at tax time.

Forgiveness Of Student Loans Taxable

Taxes And Student Loan Forgiveness [Updated 2021]

During the last year, the Biden administration has used so-called targeted student loan forgiveness to expand relief under several existing federal loan programs using executive action. According to the Department of Education, $15 billion in federal student loan debt has already been cancelled for nearly 700,000 borrowers, with more on the way. And advocates for borrowers are pushing President Biden to go even further by enacting broad student loan forgiveness through further executive action, although the administration has so far been non-committal on that.

But as we enter tax season, borrowers should keep in mind that in some cases, student loan forgiveness may be taxable. In other cases, it may not. The issue is complicated, and depends on several factors. Here’s an overview.

Student Loan Forgiveness: A Taxable Event?
As a general rule, whenever a debt of any kind — including a student loan — is reduced or cancelled, the debtor or borrower may incur taxes. The lender would issue the debtor a Form 1099-C during tax season for the year in which the debt was cancelled, which would show the exact amount of loan forgiveness or debt cancellation. The debtor may then have to report that amount on their tax return as “income.” In other words, the amount of the cancelled debt could be treated as if the borrower “earned” that sum in income during the prior tax year, resulting in additional income taxes. For large forgiven balances, this can potentially result in a hefty tax bill.

who pays for student loan forgiveness

With President Joe Biden considering canceling up to $10,000 in federal student loans per borrower, a long sought after policy dream for millions of Americans who struggled with years of repayment could become a reality.

But student loan cancellation isn’t a magic wand that makes those loans disappear—they’ll have to be paid for somehow. But the question is: By whom?

Canceling federal student loans will cost the federal government hundreds of billions of dollars— and it’s the general public that will eventually end up footing the bill.

Canceling up to $10,000 in federal student loans per borrower would cost the government roughly $245 billion, according to the Committee for a Responsible Federal Budget (CRFB). If income caps were implemented to limit forgiveness to folks with lower incomes, that would only drop the CRFB’s estimate to about $230 billion.

But what exactly does “cost the government” mean? Canceled federal student loans would be immediately added to the federal deficit, which measures how the country owes more money than it takes in during a year.

Analysts agree that canceling federal student loans would increase the deficit. But what they’re split on is how significant that addition would be, and how the government could eventually recoup the costs.

How Reducing the Deficit Can Eventually Fall on Consumers
Some express concerns about the negative effects that large amounts of national debt can have on the economy, including making it vulnerable to rising interest rates and increased inflation. But others claim that our government has run on a deficit every year since 2001 without many adverse effects, and we wouldn’t see much of an impact from canceling student loans.

The federal government had a $2.8 trillion deficit in fiscal year 2021, much of which was comprised of Covid-19 relief spending, including stimulus checks and emergency rental assistance. The deficit amounted to approximately 13% of GDP and accounted for the second largest deficit since the end of World War II.

To put that in perspective, deficits over the last five decades have averaged just 3% of GDP. The higher that percentage is, the less likely the country will be able to pay back its debt and is at a high risk of default—and default could cause mass panic in the global financial system. The CRFB’s estimate of student loan cancellation costing $230 billion would add less than 1% of the 2021 deficit overall.

A recent report by the U.S. Government Accountability Office (GAO) warns that current federal spending is at an unsustainable level and puts the country’s financial health at risk.

The government has two options to reduce the deficit: Decrease spending or raise taxes. That, according to some policy analysts, is how the cost will eventually make its way to the general public.

“There are trade-offs and it’s quite likely that if we spend this money on forgiving student loan debt we won’t spend it on other things we want to see the government do,” says Sandy Baun, nonresident senior fellow at the Urban Institute.

Spending cuts could potentially slash some of the most important social programs in the country. In 2020, the Congressional Budget Office (CBO) released a report of various strategies the federal government could use to lower its deficit. These included cutting down on vital programs, including eliminating free and reduced school lunches or raising the full retirement age for Social Security.

That means some of Biden’s social initiatives, like universal Pre-K or guaranteed parental leave, could have a tough time becoming law in the future.

Raising taxes to increase revenue could also have an impact. Not only could individual income tax rates be increased, but the CBO report suggested decreasing or repealing popular tax credits and deductions, including limiting deductions for charitable giving, as steps the government could take to increase revenues. President Biden has vowed to not raise taxes on the middle class, but what future administrations could do to rein in the deficit remains to be seen.

Those in favor of canceling federal student loans say that the people who will benefit the most from cancellation shouldn’t be the ones paying for it.

“We should increase taxes on corporations, high earners and the wealthy,” says Charlie Eaton, cofounder of the Higher Education, Race and the Economy (HERE) Lab at the University of California. “Those folks should pay more because they have benefitted from having a more educated workforce that produces the wealth that they have accumulated.”

There’s also the question of whether student loan cancellation will increase inflation. Some researchers take the stance that effectively giving consumers more money to spend, while the world reels from supply chain issues, will only push inflation up further. Others argue that half of student loan borrowers have a zero or negative net worth, and the extra money in their budget each month could go toward paying down their other debt.

About the author

The Editorial Team at Infolearners.com is dedicated to providing the best information on learning. From attaining a certificate in marketing to earning an MBA, we have all you need. If you feel lost, reach out to an admission officer.
Study on Scholarship Today -- Check your eligibility for up to 100% scholarship.

Leave a Comment