What to Tell Your Clients About Student Loan Forgiveness and Canceled Debt

TAXSLAYER EDITORIAL TEAM SEPTEMBER 12, 2022

On August 24, 2022, President Joe Biden announced a plan to erase up to $20,000 in student loan debt for individuals who borrowed money from the federal government to pay for college expenses. The plan would eliminate college debt for about 20 million people in the U.S.  In addition, the pause on federal student loan repayment has been extended through December 31, 2022. Your clients may be asking what they need to do to claim this debt relief. In this article, we cover what it takes to qualify for loan forgiveness and the tax implications of debt cancellation. Who is eligible for student debt relief? Individual borrowers who earn less than $125,000 per year (or $250,000 if they are married) are eligible for up to $10,000 in student loan forgiveness. Pell grant recipients could receive an additional $10,000 in loan forgiveness.  What does my client need to do to claim their relief? Many people will receive their student debt relief automatically. If the U.S. Department of Education has access to their current income data, then your clients do not need to take any additional steps. If not, they will need to submit an application (this will become available in October, 2022).   Clients who wish to be notified when the application is available can sign up on the DoE website.  Will my clients have to pay taxes for federal student loan forgiveness? Under the American Rescue Plan (ARP), student loan debt forgiveness between 2021 and 2025 does not count toward federal taxable income. In addition, most states will follow the federal treatment. But there is a handful of states that may still decide to tax student loan debt forgiveness. Those states are: Arkansas California Indiana Minnesota Mississippi North Carolina Wisconsin There is still time for these states to change or confirm their current tax policies on student loan forgiveness. We’ll continue to update this section as information becomes available. How is debt cancellation taxed? Canceled debt is generally taxed as ordinary income, but there are some exceptions – like student loan forgiveness. Other exceptions include: Bankruptcy Insolvency Certain farm debts Non-recourse loans Purchase price reductions Business debt where the payment would have been a deduction and the taxpayer uses the cash method of accounting How to report canceled debt using TaxSlayer Pro First, if your client has canceled debt, the lender should report the amount of canceled debt to your client on Form 1099-C.  If the canceled debt is excluded from taxable income, you’ll need to file Form 982 with your client’s tax return. If you’re reporting the canceled debt as income, the tax form you’ll use will depend on what it relates to. For example: Nonbusiness: use Form 1040 or Form 1040-NR. Nonfarm, sole proprietorship: use Schedule C (Form 1040). Nonfarm, real property rental: use Schedule E (Form 1040). Farm rental: use Form 4835. Farm: use Schedule F (Form 1040).