On August 24, 2022, President Biden announced student loan relief that could benefit up to 43 million borrowers.¹ To help you and your loved ones decipher what this may mean for your financial planning, how it may impact your taxes, or how to apply, we’ve pulled together some key highlights for you.

Debt cancellation

The biggest piece of news was outright debt forgiveness equal to the lesser of your federal student loan balance as of June 30, 2022, or $10,000 ($20,000 for Pell Grant recipients). All federal post-secondary education loans count, including Parent PLUS Loans. Private loans, including some commercially held Federal Family Education Loans (FFEL), appear to be ineligible for relief.

To ensure that relief is targeted to those who need it most, an income threshold is applied for eligibility. For single and (presumably) married filing separate, the threshold is $125,000, while married filing jointly and head of household will have a threshold of $250,000. These thresholds apply to 2020 and 2021 tax return filings, but qualification only requires income under the threshold for one of those years.

Several items have not been addressed, such as what measure of income to use. Is it gross income, adjusted gross income, taxable income, or a modified income amount? Our best guess at this point is adjusted gross income.

Is there a phase-out range or does $1 of extra income result in ineligibility for the $10,000 in debt relief? Right now, it appears to be a cliff with no phase-out range. Let’s consider an example:

Ally is single and recently graduated from college as an attorney. Her salary is $124,999 per year, and she has $50,000 in student loan debt. Since her income is under $125,000, she will only owe $40,000 on her student loans with $10,000 forgiven. If her company gives her a $1 bonus, her income will preclude 100% of the debt forgiveness.

Those who made voluntary student loan payments since March 13, 2020, when the CARES Act first created the payment freeze, may be eligible for a refund of those payments to apply for forgiveness. While this strategy is unlikely to impact very many, it could provide great value if payments were made during the freeze, income is below the thresholds, and total loan debt without the refund is below $10,000 ($20,000 for Pell Grant recipients).

Applying for relief

The Department of Education (DOE) needs income information to determine eligibility for student loan relief. For approximately eight million student loan borrowers, the information is already on file and nothing additional must be filed. For others, the DOE will release an application form in early October and, to ensure relief before 2023, the deadline for delivery is November 15, 2022. Sign up here to be notified when the application is available.

Taxes

In general, cancellation of indebtedness is treated as taxable income since the debtor is receiving an economic gain. However, Internal Revenue Code Section 108 provides several exceptions, including subsection (f)(5), which, written into law in the American Rescue Plan Act of 2021, allows for tax-free discharge of all student loans between 2021 and 2025.

According to Bloomberg, 13 states still tax debt forgiveness:

It is likely that some, or all these states, will modify their own rules to allow for tax-free student loan forgiveness.

Important takeaways

For those with federal student loans, review your 2020 and 2021 tax returns for your adjusted gross income. For levels below or close to the thresholds ($125,000 single and $250,000 married filing jointly) be prepared to complete the DOE’s application around mid-October this year. Any debt relief will take four to six weeks to show up in your account and will be federally tax-free (possibly state tax free as well).