President-elect Joe Biden and Vice-President-elect Kamala Harris at the briefing of the Transitional Covid-19 Advisory Board on November 9, 2020 in Wilmington, Delaware.
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Student loan waiver seems more of a possibility under President-elect Joe Biden, but one unintended consequence could arise if Washington does not step in: a loan waiver tax.
Biden has proposed creating a new program that will provide borrowers with $ 10,000 debt relief for each year of national or nonprofit service for up to five years.
Sens. Chuck Schumer, DN.Y., and Elizabeth Warren, D-Mass., Also said the next president could by ordinance cut up to $ 50,000 from borrowers’ balances.
The catch is that under normal debt relief or debt relief circumstances – whether you’re negotiating a balance on a credit card bill or dumping your home and underwater mortgage in a “short sale” – you owe tax on the amount waived.
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To make matters worse, although cash-strapped borrowers enjoy a temporary pardon from student loan payments, those who struggled to make payments would owe the IRS on the outstanding balance.
“That’s the thing about debt cancellation: there is no money in your bank account,” said John R. Brooks, professor of law at Georgetown University Law Center.
“You are better off because you don’t have the liability, but you didn’t generate the money to pay the taxes,” he said.
But it doesn’t have to be like that.
Indeed, a resolution passed by Schumer and Warren earlier this fall encourages the President to use the powers of the executive under the Tax Act to “ensure no tax liability for federal student loan borrowers due to administrative debt relief.”
“Right now, the IRS considers forgiveness taxable,” Brooks said. “At least there are enough legal powers to decide that it is not taxable.”
Today’s patchwork quilt of narrow solutions
There are currently a handful of provisions that allow tax-free debt relief – albeit under very tight circumstances.
First, there is the Government Loan Relief Program, which clears a borrower’s remaining federal loan balance after 120 qualifying monthly payments. Students must work for the right type of employer: a government organization or a 501 (c) (3) not-for-profit organization.
The program is far from perfect. According to September data from the U.S. Department of Education, nearly 180,000 individual borrowers have petitioned for their debts to be cleared and 3,469 have been waived.
Public utility debt relief is tax-free.
There is also the “bankruptcy exemption”, which is already inscribed in the tax code.
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“The bankruptcy exemption from debt relief is likely to apply to many taxpayers with high loans outstanding from college and graduate schools,” said Joshua Blank, professor of law at the University of California, Irvine School of Law.
He gave the example of a taxpayer with $ 200,000 in student loan debt, plus $ 50,000 in other debt and $ 10,000 in cash in a bank account – her only asset. After the “Bankruptcy Exemption”, that person would be insolvent with $ 240,000.
In this case, the person’s student debt could be waived and excluded from their income. However, there is a compromise: the insolvent taxpayer loses some “tax characteristics” or certain tax advantages, some of which are based on asset and net operating losses.
Student debts settled as a result of the death or total and permanent disability of the student are also tax-free.
Finally, this January the IRS and Treasury gave tax breaks to cheated students whose funds were cleared when their colleges closed.
A tax fix in Washington
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For now, it remains to be seen how Congress or the administration will help student loan borrowers cope with the taxes that would arise from debt relief.
One possibility could be for forgiveness to be lowered in the form of a Covid-19 stimulus package, Brooks said. Perhaps it could be viewed as “qualified disaster relief” excluded from gross income, he said.
Congress could also draft legislation to ensure that only borrowers below a certain gross adjusted income are exempt from tax, said Leandra Lederman, director of tax programs at Indiana University’s Masons School of Law.
“You could do that here,” she said. “Exclude up to $ 50,000 from income if Adjusted Gross Income is below a certain level, then take it off.”
How Washington develops a solution to taxes may depend on how the relief is introduced in the first place.
“There have been arguments back and forth that it would be hard to imagine that this would not be subject to tax liability if it were done through an executive order rather than a law,” said Kim Rueben, director of the state and local finance initiative at the Urban Brookings’ Tax Policy Center.
“If it’s taxable, now this is really bad policy,” she said. “The people who will be fine are the ones who can afford the tax debt, but the ones who struggle?”
“You’re replacing the student loan debt with debt to the IRS, and it doesn’t feel like a good exchange,” Rueben said.
source https://collegeeducationnewsllc.com/student-loan-forgiveness-may-come-with-tax-bomb-heres-what-you-should-know/
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