Here’s the tax impact if Schumer’s call for student debt reduction passes

Senate Minority Leader Chuck Schumer, Democrat of New York, holds a media availability on Capitol Hill in Washington, DC on November 6, 2020.

Nicholas Kamm | AFP | Getty Images

Senate Minority Leader Chuck Schumer, DN.Y., called on President-elect Joe Biden to forgive student loan borrowers up to $ 50,000.

“Before the new administration, the four of us call on the President of the United States to take executive action to administratively write off up to $ 50,000 in student loan debt for federal borrowers,” Schumer said.

He spoke in New York on Monday, where he was joined by Democratic MPs-elect from New York, Mondaire Jones, Ritchie Torres and – via an iPad – Jamaal Bowman.

Although debt cancellation often results in a tax bill for the borrower, Schumer said Biden can help student borrowers avoid this.

“It can also ensure that when they do, they have no tax liability,” Schumer said.

Indeed, this fall, Senator from New York and Senator Elizabeth Warren, D-Mass., introduced a resolution which calls on the next president to use executive power to write off student loan debt and prevent federal student loan borrowers from facing a tax bill.

For cash-strapped households, wiping off debt would solve the problem of monthly payments and a balance that continues to earn interest.

However, unless the tax issue is resolved, these borrowers would be grappling with one of the toughest creditors – the IRS.

“Once they write off the loans, does that debt cancellation trigger a tax bill?” asked John R. Brooks, professor of law at Georgetown University Law Center. “The tax attorney’s impulsive response is, if you write off a debt, then it’s income unless you can point me to an exception.”

“What I mean is that this simplistic view ignores a lot of other laws and stories relating to student debt,” he said. “There are different ways to approach the problem and it will be interesting to see how they evolve.”

Tightly targeted relief

There are a few situations that allow for tax free debt cancellation under current law.

First of all, there is the Public service loan forgiveness program, in which a borrower’s remaining federal loan balance will be wiped out after 120 qualifying monthly payments. Students must work for the correct type of employer: a government organization or a 501 (c) (3) nonprofit.

The program is far from perfect. Almost 180,000 unique borrowers have asked to write off their debts, and only 3,469 have been forgiven, based on September data from the US Department of Education.

Debt cancellation under the public service program is tax free.

There is also the “insolvency exception” it’s already written into the tax code.

“The debt income write-off insolvency exception likely applies to many taxpayers with heavy loans outstanding in college and graduate school,” said Joshua Blank, professor of law at University of California, Irvine School of Law.

He gave the example of a taxpayer with $ 200,000 in debt on a student loan, over $ 50,000 in other debt, and $ 10,000 in cash in a bank account – his only asset. Under the “insolvency exception”, this person would be insolvent by $ 240,000.

In this case, the person’s student debt could be canceled and excluded from their income. However, there is a compromise: the insolvent taxpayer loses some “tax attributes” or certain tax benefits, which include its asset base and net operating losses.

Disaster relief amid Covid

Portra | DigitalVision | Getty Images

For now, it remains to be seen how Congress or the new Biden administration will help student borrowers cope with taxes stemming from debt forgiveness.

One possibility could be that forgiveness is part of a Covid-19 stimulus package, Brooks said. Perhaps he could be considered a “qualified disaster relief payment“It’s excluded from gross income,” he said.

Congress could also draft legislation ensuring that only borrowers below a certain adjusted gross income receive a tax-free rebate, said Leandra Lederman, director of the tax program at the Maurer School of Law at the University of Paris. ‘Indiana.

“You can do that here,” she said. “Exclude income up to $ 50,000 from debt cancellation if adjusted gross income is below a certain level, then phase it out.”

How Washington works out a solution for taxes might come down to how they roll out relief in the first place.

“There have been arguments that if this was done by executive order rather than legislation, it is difficult to see how it would not be subject to tax,” said Kim Rueben, director of State and Local Finance Initiative at the Urban-Brookings Center for Fiscal Policy.

“If it’s subject to a tax liability, then that’s really bad policy right now,” she said. “The people who are going to do well are the ones who can afford the tax debt, but the ones who are in trouble?”

“You are replacing student loan debt with debt to the IRS, and that doesn’t sound like a good trade,” Rueben said.

Comments are closed.