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is student loan forgiveness taxable

The recent announcement that many student loan borrowers would receive forgiveness was welcome for millions of people. However, many borrowers wonder whether the forgiveness comes with tax consequences. We’ll walk you through how student loan forgiveness works, whether student loan forgiveness is taxable, and other considerations.

How Does Student Loan Forgiveness Work?

In late August, President Biden announced that borrowers with federal student loans making less than $125,000 (or $250,000 for a married couple) would receive $10,000 of student loan debt forgiveness. Borrowers can qualify based on their 2020 or 2021 income. Note that the limit is a per-borrower limit, so each person in a married couple would receive $10,000 in loan forgiveness if they meet the requirements.

Borrowers that received Pell Grants are eligible for up to $20,000 in student loan forgiveness. If you are unsure whether you received Pell Grants, the IRS is setting up a tool that borrowers can use to review their loan history.

There are over 1.75 trillion dollars in outstanding student debt, when considering all federal and private loans. This total averages out to approximately $28,000 per borrower. 

This plan is expected to erase approximately 20 million borrowers’ student loan debt, nearly half of those with outstanding student loan debt.

Student loan borrowers who made payments during the COVID pandemic payment pause also have a chance to get their payments refunded under Biden’s forgiveness plan. 

The plan also includes provisions that reduce the number of years a borrower must be enrolled in an income-driven repayment plan before the loan is written off.

Student Loan Forgiveness 2022: Restrictions and Limitations

Not everyone will qualify for student loan forgiveness. The Biden administration has promised to automatically apply the forgiveness to anyone on an income-based repayment plan, since they already have income eligibility data.

All other borrowers will have to fill out an application, which is expected to be released in October. The government has not released the application yet, so it’s uncertain what information will be requested when it is finalized.

What Are the Income Caps for Student Loan Forgiveness

To qualify, borrowers must have earned less than $125,000 in 2020 or 2021. In addition, married borrowers’ income must have been less than $250,000 in either 2020 or 2021. Married couples’ eligibility is determined by their joint income if they filed a joint return, so both spouses would qualify even if one makes more than $125,000 as long as their combined income is under the $250,000 limitation. 

If you haven’t filed taxes for these years, you should do so as soon as possible to ensure you qualify for student loan forgiveness.

Tips for Meeting the Income Requirements

If you are close to the 2020 or 2021 tax years threshold, you should review your return to ensure that you took all applicable deductions. If you missed a deduction, you should amend your tax return.

There is no phase-out range for student loan forgiveness. You will either qualify for the total amount or not receive any forgiveness. The amount is limited to your outstanding student loan debt plus payments made during the pandemic payment pause.

What Types of Loans Qualify?

Several types of loans qualify for forgiveness, including undergraduate, graduate, and Parent PLUS loans. 

However, private loans aren’t eligible for forgiveness. Additionally, borrowers with federally backed loans made by private lenders, like Federal Family Education Loans, won’t qualify for forgiveness, either. 

In addition, the forgiveness plan only covers loans borrowed before June 30, 2022.

Is Student Loan Forgiveness Taxable?

The American Rescue Plan Act exempts student loan forgiveness from taxation at the federal level until the end of 2025. However, the government will process most forgiveness applications before the end of 2023, so you probably don’t need to worry about federal income taxes.

However, states have their own taxation rules

Currently, several states plan to levy income taxes on student loan forgiveness. These states include Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin. Tax rates vary depending on your state and income bracket.

It’s possible that states will change their rules to exclude the forgiveness before the 2023 tax filing season.

How to Minimize Taxes on Student Loan Forgiveness

If you live in a state that will tax your student loan forgiveness, your best bet is to reduce your taxable income as much as possible by finding qualified deductions.

For example, you can deduct up to $2,500 in student loan interest from your taxable income and reduce your total taxable income.

You can also lower your gross income by contributing to certain retirement and savings accounts. Traditional IRAs and healthcare savings account have maximum limits of $6,000 or $3,650, respectively. Retirement contributions can further reduce your taxable income, dollar-for-dollar.

If you have a regular brokerage account, you can also sell stocks for capital losses. You can deduct up to $3,000 in capital losses yearly from your taxable income.

For people planning on moving to a different state next year, check your new state’s rules on student loan forgiveness taxation. If your destination state doesn’t tax student loan forgiveness, you should wait to apply until after the move.

Final Thoughts

Residents of certain states should know about their local taxation rules in advance. Student loan forgiveness taxes will only make up a small portion of the forgiven amount, but you should still prepare for a slightly higher state tax bill on tax day.

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