What President Biden’s Student Loan Forgiveness Program Means for Your TaxesSeptember 19, 2022
In August, President Biden made a long-awaited announcement: The federal government would forgive up to $10,000 of student loan debt for low- to middle-income borrowers. Borrowers that had received Pell Grants could be eligible for even more assistance.
But after the initial excitement wore off, many people wondered if they’d face a hefty tax bill due to this new measure.
Although new laws were implemented that excluded student loan forgiveness from taxable income at the federal level, the student loan tax rules can vary by state. Continue reading to find out how you may be affected by the student loan forgiveness program.
President Biden’s Student Loan Forgiveness Program
Although loan forgiveness was available to some borrowers with federal student loans previously, only a tiny percentage of borrowers qualified. Federal programs like Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness were limited to a small segment working in education or public service; those that worked for for-profit corporations weren’t eligible.
By contrast, the new loan forgiveness program announced by the Biden Administration is available to all borrowers with federal Direct student loans.
Under the program, borrowers can qualify for up to $10,000 in student loan forgiveness. If the borrower has received a Pell Grant, they are eligible for up to $20,000 in loan forgiveness.
Borrowers are eligible for the program if their incomes are under $125,000 ($250,000 for married couples).
Additionally, the federal payment freeze was extended again. Payments are paused through December 31, 2022, and interest remains at 0%.
How Does Loan Forgiveness Affect Taxpayers?
Although President Biden”s announcement provided some relief to federal student loan borrowers, many people are worried about how it will affect their taxes.
In the past, the IRA considered forgiven student loans to be taxable as income. For example, if you earned $40,000 per year and qualified for $10,000 of loan forgiveness, the IRS would view your taxable income as $50,000.
However, there have been some changes, so you may not have to worry about taxes on your loan forgiveness.
Previously, all forms of loan forgiveness other than PSLF were taxable as income at the federal level. However, the Biden Administration passed the American Rescue Plan, which changed that rule through 2025.
Under the American Rescue Plan, loan forgiveness is not taxable as income on federal income taxes. You don’t have to worry about federal income taxes if you are eligible for $10,000 or even $20,000 under the new loan forgiveness program.
Although federal income tax isn’t an issue with loan forgiveness; the forgiven amount may be taxable as income at the state level.
Not all states with income taxes consider loan forgiveness to be taxable; many states have amended their laws to make loan forgiveness exempt from taxation. According to the Tax Foundation, a non-profit organization focused on tax policy, and there are currently seven states that will tax student loan forgiveness:
- North Carolina
Some states are revisiting their tax laws regarding loan forgiveness so that this list may change in the future.
How Much Will Loan Forgiveness Affect My Taxes?
If you live in a state where loan forgiveness is taxable as income and are worried about how it will increase your tax bill, it may not have as big of an impact as you expect.
When calculating what you must pay, you need to know your marginal and effective tax rates.
- Effective tax rate: Your effective tax rate —sometimes called the average tax rate — is the percentage of your income you pay in taxes.
- Marginal tax rate: By contrast, your marginal tax rate is the tax rate imposed on the last portion of your income.
For example, Joe lives in Arkansas, is single, and earns $40,000 yearly. At the state level, his marginal tax rate is 5.90%, and his effective tax rate is 5.58%. Before loan forgiveness, he would pay $2,230 in state income taxes.
Joe qualified for $10,000 through the new loan forgiveness program. Because Arkansas considers loan forgiveness income for tax purposes, the forgiven amount is added to his income. For state income taxes, his income is $50,000.
With the higher income, Joe’s marginal tax rate is still 5.90%, but his effective tax rate is 5.64%. At that rate, he would pay $2,820 in state income taxes. Due to loan forgiveness, his tax bill would be $520 higher.
Even if he qualified for $20,000 of loan forgiveness, it would impact Joe’s tax bill by less than $800.
|State Taxes Without Loan Forgiveness||State Taxes With $10,000 of Loan Forgiveness||State Taxes With $20,000 of Loan Forgiveness|
|Effective Tax Rate||5.58%||5.64%||5.68%|
|Marginal Tax Rate||5.90%||5.90%||5.90%|
|State Income Tax Total||$2,230||$2,820||$3,410|
Source: Forbes Income Tax Calculator
Filing Your Taxes
President Biden’s student loan forgiveness program will give millions of borrowers some assistance with their student loans. However, some borrowers may have to include the forgiven amount as taxable income on their state tax returns.
If you are concerned about loan forgiveness and student loan tax rules, consider hiring a certified public accountant (CPA). A CPA can review your unique situation, help you prepare for tax time, and ensure your taxes are filed correctly.
You can find a CPA near you with the Association of International Certified Professional Accountants’ database.