If you’re among the more than 40 million Americans who have a federal student loan, you likely know that in August, the Biden administration extended the payment moratorium on student loans until December 31, 2022 while also announcing a plan that will cancel some debt for certain borrowers. The Department of Education officially launched the application allowing Americans to apply for this debt relief on October 17.
However, on November 14, a federal appeals court in St. Louis agreed to an injunction while it reviews several cases challenging the debt relief plan. This has halted the debt cancellation process but administration officials continue to assure eligible borrowers that the program will eventually proceed as planned.
Then, on November 22, the White House and the Department of Education again extended the payment moratorium on student loans, as the latest payment pause extension was made in conjunction with the student loan forgiveness plan. Borrowers with federal student loans won’t have to make payments, and loans won’t resume accumulating interest until 60 days after current court cases challenging the student loan forgiveness program are resolved. If the cases aren’t resolved by June 30, 2023, payments will resume two months after that.
If indeed the program resumes as the administration plans, you may still have questions about how this process will work and how it may affect your future financial plans — including how it could impact your tax returns. Here’s what you need to know about how receiving forgiveness for your student loan debt could affect your finances.
Who is qualified to apply for forgiveness on student loans?
Borrowers who received federal student loans before June 30, 2022 can apply for relief through the plan, which forgives up to $10,000 in federal student loan debt for those who make less than $125,000 per year (for individuals) or $250,000 (for married couples or heads of households), based on either 2020 or 2021 income. Pell Grant recipients who meet those income standards are eligible to have up to $20,000 in debt forgiven. Debt relief is capped at the amount of outstanding debt. The Congressional Budget Office estimates that these income limits will make 95 percent of borrowers eligible to receive loan forgiveness.
Which types of loans are eligible?
Most federal student loans qualify for forgiveness, including government-held Federal Family Education Loans (FFEL), government-held Perkins Loans, and all loans through the Direct Loan program, including Parent PLUS and Grad PLUS loans.
The forgiveness does not apply to private student debt or certain loans from the Federal Perkins Loan Program and FFEL loans with private lenders.
How does the application work?
Nearly 8 million borrowers whose income information is already on file with the Department of Education (such as from filling out the FAFSA) will receive an email from the department and do not have to apply; however, the department encourages everyone eligible to apply anyway.
Due to the ongoing legal challenges, the StudentAid.gov website has taken down the online application and replaced it with a link that borrowers can use to subscribe for updates. If you have already applied, the department will hold onto your application.
If you have not yet applied, once the online application reopens, you’ll need to fill out basic information: your name, birth date, Social Security number, phone number and email address. The department estimates that it will take about five minutes to complete as it does not require logging in or submitting any documents. Applicants will have to sign a form and check a box certifying that they meet the eligibility requirements.
How long will the loan process take?
The Department of Education plans to match the information applicants provide with the loan and income information it already has on file and says it will contact the borrower if more information is needed. The administration has said most applicants can expect to receive relief within six weeks after their application has been processed — that is, once the application reopens.
Can I get a refund on student loan payments made during the COVID-19 pandemic?
Refunds for any payment (including auto-debit payments) you have made during the payment pause (which began on March 13, 2020) will be available, according to StudentAid.gov. However, the process could take up to a few weeks or months, so it’s a good idea to contact your loan servicer to request that your payment be refunded as soon as possible.
How will receiving loan forgiveness impact my taxes?
The IRS typically treats cancelled and forgiven debt as taxable income but student loans that are forgiven will be exempt from federal income tax because of the 2021 American Rescue Plan, which included a provision preventing taxation on student loans forgiven through 2025.
This is where things get trickier. Depending on where you live, your forgiven debt may fall into one of three categories:
- Definitely won’t be taxed. Nine states — Alaska, Florida, Nevada, New Hampshire, North Dakota, Tennessee, Texas, Washington and Wyoming — have no state income tax, which means they will not tax your forgiven debt.
- Likely will be taxed. According to the Tax Policy Center, four states — Indiana, Minnesota, Mississippi and North Carolina — plan to treat forgiven student loan debt as income. Meanwhile, Arkansas, California and Wisconsin are currently reviewing their tax rules.
- May or may not be taxed. Some states readily align (or in tax-speak, “conform”) their relevant statues, rules and regulations to federal legislation. Others have existing tax statutes that require their state officials to enact legislation to align its statues with the federal government’s. For example, tax officials from Massachusetts, New York and Pennsylvania have announced that there will be no tax on student loan debt discharge despite ambiguities in their state laws. Because the student loan relief was just announced, most the states are playing catch-up on this issue.
So, if your state is among those that could or will tax student loan forgiveness, you will need to stay tuned for any guidance or information that is made available or reach out to your state government office for updates. If you do have concerns about your potential state tax liability, you could choose to opt out of this one-time student loan debt relief. To do so, the Department of Education recommends that you contact your loan servicer.
It’s always a good idea to discuss your options with a tax professional before taking any action that may significantly impact your tax liability.
This publication is not intended as legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor.