Student loan borrowers won't face a surprise tax bill after debt forgiveness

Normally debt forgiveness would be taxed, but Democrats already thought of that and made a carveout in their big pandemic stimulus bill last year.

• On Wednesday, President Joe Biden announced student loan cancellation for some borrowers.
• Some student loan holders can see $10,000 forgiven, and Pell Grant recipients will get $20,000 off.
• Normally, that would be taxed, but Democrats ensured that wouldn't happen last year.

President Joe Biden finally made his long-awaited announcement: Student loan forgiveness is here. And there's an extra bit of great news for borrowers who are about to see relief: It won't mess up their tax bills, due to a provision Democrats included in their big pandemic stimulus law last year.

On Wednesday, Biden announced he was cancelling $10,000 in student-loan debt for some borrowers, and up to $20,000 for borrowers taking out Pell Grants reserved for lower earners. The administration estimates that the forgiveness will impact 43 million borrowers, with around 20 million seeing their debt wiped out completely.

But all of those borrowers could have also experienced a more unpleasant surprise come tax filing season — if not for Democrats thinking ahead.

"Typically, loan forgiveness is treated as taxable income. This makes sense from a big-picture tax policy perspective," John Buhl, an analyst at the Tax Policy Center, wrote in an email to Insider. "But for someone getting $10,000 or $20,000 in forgiveness, that could equate to a year-end tax bill well into the four figures. That could put some taxpayers in a difficult financial position in the short-term, even if the monthly payments on their remaining student loans were lower in the future."

The final text of last year's American Rescue Plan — which sent out a fourth round of stimulus checks and expanded the child tax credit — included a provision that makes sure relieved student loan borrowers won't get saddled with a big tax bill. From 2021 to 2025, forgiven student loans won't be included as part of gross income. Democrats similarly made $10,2000 of unemployment benefits exempt from taxes in the stimulus package.

"Thanks to the American Rescue Plan, this debt relief will not be treated as taxable income for the federal income tax purposes," the White House said in a fact sheet.

That tax relief actually stems from a piece of legislation introduced by Sens. Elizabeth Warren and Bob Menendez, called the "Student Loan Tax Relief Act." 

"As a result of my work with Senator Warren in authoring and passing the Student Loan Tax Relief Act, which was successfully included in the American Rescue Plan last year, millions of Americans will not face a surprise tax bill next year because of the President's historic decision to cancel student debt," Menendez, a Democrat from New Jersey, said in a statement.