Millions of borrowers may benefit from student loan forgiveness

Bill Cass, CFP®, CPWA®

Bill Cass, CFP®, CPWA®, 08/31/22

After months of speculation, the Biden administration announced broad forgiveness of federal student loan debt for debtors who meet certain income requirements. The administration is leveraging language in the 2003 HEROES Act and response to the pandemic crisis as authority to move forward on debt forgiveness without congressional action. Legal challenges in opposition of this executive action may emerge.

While there is lack of clarity on some details, here are highlights of what is known today.

Eligible borrowers may see up to $10,000 of existing debt forgiven (up to $20,000 if the student received a Pell Grant in college). Additionally, the pause on student loan payments introduced during the pandemic was extended from the end of August to the end of 2022. The Department of Education indicated this would be the last extension in the suspension of payments.

Lastly, the administration announced changes to existing income-driven repayment plan programs including a cap on student loan debt payments at 5% of discretionary income (reduced from 10% of income currently).

student debt has soared

Eligibility depends on income level

To benefit from the forgiveness program, debtors must report less than $125,000 in income ($250,000 for couples filing a joint tax return) for either their 2020 or 2021 tax returns. For a student debtor claimed as a dependent on the parent’s tax return, the parent’s income will be considered to determine eligibility for forgiveness.

While additional details will be forthcoming, adjusted gross income (AGI) is the most likely measurement of income to be applied. Lastly, it is not yet clear whether an income phaseout will apply, meaning that debtors above these income levels may still be able to benefit from a portion of forgiveness until the benefit is fully phased out at a higher income level.

Parents may be eligible too

The program applies to federal student loans, including Parent PLUS loans. Federal loans held by graduate students are also eligible for forgiveness, while private student loans are not generally eligible for forgiveness. Currently, it’s not clear whether some loans, such as Family Federal Education Loans (FFEL) held by private loan servicers, will be eligible. Additional clarification from the Department of Education is expected.

Will taxes be owed on discharged debt?

Typically, the tax code considers discharged debt as income to the debtor. However, this program states that student loan debt that is forgiven will not be considered income for federal tax purposes. However, since not all states directly comply with the federal tax code, some borrowers may have to report forgiven debt as income on their state tax return.

What’s the next step?

The Department of Education indicated that for some borrowers for whom they have income information, the student loan debt forgiveness will be automatic. For others, an application will be available before the end of the year to apply for forgiveness.

Borrowers to monitor updates

Debtors will want to monitor updates on this program. It is particularly important to consider state tax implications in case they need to file forgiven debt as part of their income.