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Student Loan Forgiveness

Zach Cox, CPA

Director of Financial Education

Last Updated
August 29, 2022
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Here’s What You Should Know

In every office around the U.S., talks around the watercooler (full disclosure, I’ve never actually seen a watercooler in an office) have been dominated by the announcement from President Biden and the U.S. Department of Education to forgive student loans. The plan, officially titled the Student Debt Relief Plan, fulfills one of Biden’s main campaign promises of debt forgiveness while also providing additional relief to student loan borrowers. As there are roughly 45 million borrowers currently holding $1.62 trillion in total outstanding federal student loans, this is a relevant topic that will affect many working Americans.

The plan includes three parts:

Part 1: Repayment Pause Extension

The plan extends the student loan repayment pause through December 31, 2022. They have announced (and have reiterated numerous times) that this will be the final extension of the pause. All student loans held federally will have their payments and interest resumed in January 2023.

  • The pause includes, but is not limited to, 0% interest, no payments due, no income-driven repayment plan recertification requirement and all months counting toward public service loan forgiveness (PSLF) and income-driven plan forgiveness.

Note: We recommend planning now for the restart of what can be a large monthly expense. Also, any major life changes (marriage, divorce, job change, etc.) may impact your student loan planning strategy; planning now before the expiration of the repayment pause will ensure you’re on the right track.

Part 2: Debt Cancellation

The plan grants student debt cancellation of up to $10,000 (or $20,000 if you ever received a Pell Grant), for those who have federal student loans. This relief is expected to wipe out all student loan debt for up to 14.6 million borrowers, or 32% of all borrowers.

  • Your relief is capped at the lessor of your outstanding debt or $10,000 ($20,000 if you received a Pell Grant), per borrower. You can check to see if you’ve ever received a Pell Grant at studentaid.gov.
  • To be eligible for forgiveness, your annual income must be under $125,000 if single (or married filing separately) or under $250,000 for those married filing jointly (or as head of household). Please note, this income limit is a cliff and not a phaseout. Once you’re over these limits, you receive no forgiveness. They have not officially announced as of August 28, 2022, what year or income calculation they will base this limit on. But it’s expected it will be based on your adjusted gross income (AGI) from your 2020 or 2021 tax return, if either year was under the income threshold.
  • Nearly eight million borrowers will automatically receive forgiveness, as the U.S. Department of Education already has the needed income information (if, for example, you previously applied for an income-driven repayment plan). For the remaining eligible borrowers, the Administration will create an application process in the coming weeks to submit your information. You can sign up now to be notified when the process is launched at ed.gov/subscriptions.
  • The loans eligible for forgiveness are those held by the U.S. Department of Education, which includes Direct Stafford Loans, Direct subsidized and unsubsidized federal student loans, Parent Plus loans, Grad loans and some Federal Family Education Loans (FFEL). It doesn’t include private loans (including those that used to be federal loans and have been refinanced), loans that have been paid in full (see exception below) or state loans.
  • Loan forgiveness is on a per borrower basis versus a per student basis. This could allow a parent who took out a Parent Plus loan and a student who also took out a loan to both qualify for the $10,000 forgiveness if they meet the income thresholds previously mentioned.
  • The loans must have been taken out by June 30, 2022, to be eligible (you can stop filling out your loan application now, plus you know you don’t want to have to study again!).
  • Active students in graduate school are also eligible to receive forgiveness. The income used to determine their eligibility will be based on their parents’ income if they were claimed as a dependent.
  • If you made payments on your federally held student loans after the CARES Act COVID waiver started on March 13, 2020, you’re eligible to request a refund on the amount paid and have the debt be forgiven. If you made payments during this period, call your loan servicer and request a refund. You’ll need to confirm the dates and amounts paid.
  • The plan also provides changes for those with loans eligible for the Public Service Loan Forgiveness (PSLF) program to have their debt fully cancelled.
    • The PSLF program is for those employed by non-profits, the military, or federal, state, tribal, or local government.
    • The changes waive certain eligibility criteria in the program and allow borrowers to receive credit for past periods of repayment that otherwise would not have qualified for PSLF.
    • This is a temporary change that is available until October 31, 2022.

Note: As forgiveness eligibility is expected to be based on your 2020 or 2021 income, there isn’t any income planning you can implement unless you have yet to file your tax return. For example, assume your combined income is over the $250,000 income limit for forgiveness due to a high-earning spouse. If you earn less than $125,000 and have student loans, you have the opportunity to file as married filing separately to meet the income eligibility limits. Please be sure to take in all considerations before implementing this strategy, as there could be numerous other tax consequences. Also please note that you cannot amend tax returns to change your filing status to married filing separately.

Another opportunity if you’re a business owner and have not filed your returns yet could be making retirement plan contributions to bring your income under the thresholds.

While cancellation of debt is typically considered taxable income, this debt forgiveness will be tax-free on your federal return. However, some states may still tax your debt forgiveness.

Part 3: Student Loan System Changes

The plan proposes to create a new income-driven repayment (IDR) plan that will lower monthly payments.

  • Borrowers would pay no more than 5% of their discretionary monthly income on undergraduate loans, a decrease from 10% in the current IDR plan.
  • The amount of non-discretionary income will be expanded to lower the amount of discretionary income used in the above repayment calculation. This will result in those borrowers earning less than 225% of the federal poverty level (said to be those working full-time at $15 an hour) to have no monthly payment.
  • Borrowers with loan balances of $12,000 or less will receive forgiveness on any remaining amount after 10 years of payments, down from the current 20-year requirement.
  • The plan also calls for the government to cover any unpaid monthly interest by the borrower, resulting in the loan balance never increasing. The loan balance won’t increase even if the borrower was making no monthly payments due to their income being below the 225% federal poverty level as stated above.

Note: We expect much more information, including draft regulations, to be released regarding this part of the plan. This will likely not be available until 2023 at the earliest and may have numerous changes.

This announcement may be very exciting for you and your friends, but patience is going to be needed. It will likely take months for the administration and the Department of Education to implement and carry out parts 2 and 3 of their plan. Also, many expect this plan to be challenged in court, which could further delay enactment. We will continue to monitor the situation and provide updates and planning strategies around the Student Loan Relief Plan and its parts.

Sources:

  1. https://www.forbes.com/sites/dereksaul/2022/08/24/bidens-student-loan-forgiveness-plan-heres-who-benefits-most-and-least/
  2. https://studentaid.gov/debt-relief-announcement/
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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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