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Goldman Sachs – How President Biden‘s student loan forgiveness could throw you a big tax bomb

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(Yahoo/KAKE) – Even if you don’t have to make student loan payments now due to the extended pause thanks to COVID, you are probably not looking forward to the day you have to begin making payments again. But what if someone could make all those loan problems go away?   

President Biden is not endorsing that type of plan, but both he and very loud backers have looked at the idea of cancelling thousands of dollars in student debt per person.   

With both the U.S. House and Senate now run by Biden‘s Democratic party, the chances for broad student loan relief look fairly good.

It is important to understand that even if Biden‘s idea becomes reality, they won’t completely wipe out everyone’s student loans and could come with a huge “tac bomb” for you. After all, nothing in life is free.

Here’s what you need to know: 

How much debt could be forgiven?

Americans have over $1.7 trillion dollars in student debt, according to the Federal Reserve. Payments on student loans have been put on hold until September.  

But Biden wants to go further. He has said he supports legislation that would “immediately” forgive $10,000 in federal student loan debt per person.

Borrowers are in “real trouble,” Biden opined during a mid-November briefing. “They’re having to make choices between paying their student loans and paying their rent, those kinds of decisions.”

Some Democrats want a $50,000 cancellation of student loans instead, as form of economic stimulus.

What might actually happen?

Washington DC Capitol with waving flag on cloudy day

Besides widescale loan forgiveness, there are other ideas being discussed to help Americans lower their student debt. These include improvements to the government’s income-based loan repayment program and the current Public Service loan Forgiveness Program.    

However, the measures will be very, very expensive. Biden may be unable to pass them if he encounters objections from conservative Democratic senators, because the Senate’s new Democratic majority is razor-thin.

Other backers argue that if Biden wished, he could use an executive order to cancel debt under the 1965 Higher Education Act, but that could lead to a major legal battle for the new administration.

Or, Biden could try to pass a watered-down plan that might have wider appeal in Congress. A compromise could target only borrowers who are in serious economic distress — and it may not be tax-free.

Normally, you need to pay income taxes on the balance of canceled debt, as if you “earned” it in cash. In other words, if you get $10,000 of student loans forgiven, it will count as taxable income.

Goldman Sachs suggests borrowers may be on the hook for as much as 20% of the amount forgiven, Fintech Zoom reports.

In his campaign platform, Biden said he would amend the tax code to make forgiveness through the existing income-based repayment program tax-free, saying “Americans shouldn’t have to take out a loan to pay their taxes when they finally are free from their student loans.”

While Schumer is calling for any and all student loan forgiveness to be tax-free, you’ll definitely want to start putting some money aside for taxes, just to be on the safe side. If some of your debt is forgiven and you can’t afford your tax bill right away, the IRS will begin charging you interest and fees.

What are your other options?

It’s crucial to recognize that the $10,000 and $50,000 loan forgiveness proposals apply only to federal student loans. Private loans a person gets from a bank or nongovernment lender do not qualify.  

So if you have a private loan — or if you don’t think Biden and his supporters will get their way — you’ll have to pursue other options.

Interest rates on private student loans have dropped during the pandemic. So, borrowers with either private or federal loans might want to consider refinancing — that is, trading an old loan for a new one at a much lower interest rate and with lower monthly payments.

Switching from a federal student loan to a private one will make you ineligible for any government relief in the coming months, though. That could be a tough call to make.

But if you currently have a private loan, there’s no downside to trying to refinance. Refinancing now while rates are cheap could significantly reduce your payments, saving you thousands over time and allowing you to pay off the balance years sooner.

James Albert

James Albert

James Albert is a personal-finance analist for FintechZoom and is based in New York. Contact: james.albert@fintechzoom.com

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