The Biden Administration is moving forward with its plans for student loan debt relief. A platform that has been near and dear to this administration’s heart since they were out on the campaign trail. Regardless of your political leanings, knowing what this means for your tax clients will be critical in providing sound advice.
The currently proposed debt relief will be $10,000 in student loan debt forgiveness per individual earning $125,000 or less. It remains to be seen exactly how this will be administered.
Loan administrators are expected to process applications for qualified individuals. The $125,000 income cap has yet to be defined, but it would stand to reason that it will be based on tax return AGI.
The big question remains, however, how will debt forgiveness impact taxes?
According to the tax code, debt forgiveness is traditionally taxable. The 2021 American Rescue Plan Act made student loan debt forgiveness, specifically, not taxable at the Federal level. The average American would have otherwise owed approximately $2,200 on the $10,000 of debt forgiveness—a potentially unexpected tax burden. While the Federal rules are clear, the state rules do not share the same clarity.
Not every state followed suit in adopting the Federal treatment of student loan debt forgiveness. That means that depending on the residency of taxpayers, they may or may not owe state income taxes on any debt forgiveness they receive. Tax professionals are yet again facing challenges with accurately applying the varying rules when filing client returns.
Professionals should stay on top of the issue as it unfolds and particularly pay attention to the regulations of the state they work in to be prepared to advise their clients. Because the debt forgiveness does not come in the form of cash payments, having an unexpected tax bill will likely come as an unwelcome surprise to many taxpayers.