A Double Dose Of Grace Dished Out With Federal Student Loan Forgiveness

When you take into consideration that some people have been paying off student loans sometimes decades after they graduated, a collective cheer must have been released into the ethers on August 24th when President Biden announced plans to forgive federal student loan debts. Specifically, the Biden administration is cancelling up to $10,000 in federal student debt for most borrowers and up to $20,000 for Pell Grant recipients.

In addition to the relief of having their loans discharged, the same borrowers may also enjoy the benefit of being able to avoid paying federal taxes on the loan forgiveness. Typically, the forgiveness or cancellation of a debt constitutes taxable income on the federal level.

The forgiveness applies only to federal student loans and only for qualified borrowers. That is, you must have earnings of less than $125,000 a year if you are single or $250,000 for joint filers. The forgiveness does not apply to those whose income is higher, nor does it apply to those who have private loans.

As an example, let’s say that you have an annual salary of $50,000 and owe $10,000 on a federal student loan. The federal income tax on that amount would be $1,200 when the loan is forgiven. But under the forgiveness and the American Rescue Plan, both are wiped out! When you consider that some people have been paying their federal student loans for years, that can only be defined as amazing grace! No more $10,000 debt and no tax debt!

Be aware though that the tax benefit only applies to federal taxes not to state taxes. You’ll want to check with your tax advisor to find out if you will owe state taxes on the forgiven federal loan.