A Game of Loans

On August 24th,2022, the Biden administration released its plans to forgive upwards of $20,000 in student loans to Federal Pell grant recipients and up to $10,000 for anyone who did not receive the grant. This aid came with the restriction that single filers collect less than $125,000 in income with the limit for married couples set at $250,000. In lieu of these expansive payments, certain credits offered under the Public Service Loan Forgiveness program would be expanded to offer additional coverage to those who work for a non-profit, the military, federal and state workers, and tribal or local governments. In conjunction with the direct compensation, the Department of Education proposed reducing the monthly cap for student loan payments at 5% of a borrower’s discretionary income, which would reduce most existing plans installments to half of what they currently are. While the announcement received general praise from its potential beneficiaries, a significant amount of opposition was raised at the question of the unprecedented moves’ legality. Challenges were soon raised, with multiple lawsuits generated at preventing the nearly $400 billion spending measure. It has since incurred a tangle of litigation. As of this Monday, November 14th, a Federal appeals court ruled an indefinite halt to the plan stemming from a lawsuit initiated by six states (Nebraska, Missouri, Arkansas, Iowa, Kansas, and South Carolina) who claimed the policy would directly hurt them economically. Their allegation is centered primarily around lost state revenue, such as the Missouri Higher Education Loan Authority (MOHELA), a private student loan provider, asserting that such a move would drastically reduce their overall revenue by mitigating its’ stream of interest and associated fees with the present cancellation of numerous accounts. MOHELA then goes to state that it would then be unable to adequately fund students at Missouri’s higher education institutions and would also be unable to fund its interconnected obligations to the state treasury, a reliable source of funding for Missouri. Arguments provided by the other states mirror this situation. As its defense, the White House claims authority for the secretary of education to alter student loan financial programs in the event of a war, direct military operation, or national emergency i.e., the COVID pandemic.

What does this uncertainty mean for any taxpayer who might otherwise secure forgiveness? Well, the short answer is that there is no way of knowing whether the executive order will eventually pass all its requisite hurdles. As of this moment it appears highly unlikely that any payments will be made for the current 2022 tax year, with early 2023 likely to be the soonest possible period for any disbursements. Should the forgiveness pass, the Federal Government has already indicated it will not tax any payments sent out for student loan forgiveness. The same cannot be said for every state; however, with Minnesota, Indiana, North Carolina, and Mississippi currently planning on including the payments as taxable income. As of this writing Wisconsin, Arkansas, and California are still considering whether to follow suit. Anyone who may opt to accept the forgiveness payments should be aware of the potential ramifications that may have on their tax liability for either 2022 or 2023 when or if the spending measure occurs. For example, a subsequent increase of $1,600 would be incurred by a median California taxpayer earning $64,000 a year with $20,000 of forgiveness. Additionally, borrowers should be mindful of the eventual resumption of student loan payments following the pause granted by the government, which is currently set to expire on December 31st, 2022. Another extension is already being considered with the confusion around the current forgiveness plan. To be safe, those who may still be required to pay monthly installments on their loans should budget for them to resume soon. In the meantime, anyone who so qualifies for a student loan interest deduction (a modified adjusted gross income of $85,000 or less for single filers and $170,000 or less for joint filers in 2022) should be sure to hold onto their 1098-E and include the form/interest received from their lender in their returns or provide it to their tax consultant.