Do I Pay Tax on the Student Loan Forgiveness?
Student Loan Forgiveness
On August 25, 2022, President Biden signed an executive order to forgive select student loan indebtedness for those with qualifying income. This is welcome news to many, but for others who have paid off their loans, it can be personally offensive. Some economists say that it is irresponsible during the inflationary period that we are in.
Regardless of the politics involved, there are 4 main parts to the order:
Continuation of the payment deferral and interest until the end of 2022 for Federal loans
$10,000 of forgiveness for those holding student loans
$20,000 of forgiveness for those who received Pell grants
Those who are employed by non-profits, the military, or federal, state, Tribal, or local government may be eligible to have all of their student loans forgiven through the Public Service Loan Forgiveness (PSLF) program. Continuation of deferral: nothing needs to be done as it will be automatic for loans held by the Department of Education. For the 2022 tax year, these loans will have no student loan interest. The order vaguely promises that this will be the last extension.
$10,000 Forgiveness: This is allowed for loans held by the Department of Education if your AGI (Adjusted Gross Income) on your tax return was less than $125,000 for singles and $250,000 for joint / Head of Household filers in either the 2020 or 2021 tax year.
$20,000 Forgiveness: For those who received Pell Grants to pay for tuition, the order allows up to $20,000 of forgiveness using the same income limits as the $10,000 forgiveness provision.
PSLF Loans: This is a Public Service Loan Forgiveness program. This is time-limited and expires on October 31, 2022. Go to www.PSLF.gov for more details.
Limitations
Taxation of the Debt Forgiveness
For Federal purposes, the cancellation of debt will not result in additional tax due to legislation in 2018 that suspended the federal taxation of student loan forgiveness through 2025. HOWEVER, there are 14 states that do not automatically conform to that 2018 Legislation. Those states will have to decide whether they will follow the law for student loan relief. Those states are AR, HI, ID, KY, MA, MN, MS, NC, NY, PA, SC, VA, WV, and WI. Taxpayers residing in these states may see an additional state tax bill, although NY and HI are moving towards exempting it.
Legal Challenge
The debt relief was not authorized by Congress and there is a possibility that the Executive Order will be challenged in court. If the courts strike down the order, Congress will have to pass a law allowing it. A number of Democrats have been opposed to loan forgiveness and even Speaker Pelosi stated that President Biden did not have the authority to cancel student loan debt.
Travelers Beware
Since many traveling healthcare and other mobile professionals receive significant amounts of tax-free per diems, there is the risk of losing the forgiveness should a later audit determine that the per diems (stipend, allowances, reimbursements – all the same) were not substantiated. With a revitalized IRS ready to tackle the tax gap found in reimbursement / per diem programs, the existence of a valid tax home is an absolute necessity. An adverse audit that adds back the tax-free reimbursements for lodging and meals could put the taxpayer over the income threshold for forgiveness and result in the debt being reinstated.