North Carolina Low-Income Taxpayer Clinic – Taxation of Forgiven Student Loans
October 27, 2022
Agenda
Federal Taxation of Student Loans Forgiven Under the Biden Administration's Student Loan Debt Relief Plan
General Rule:
Although borrowed funds are not income for income tax purposes, a taxpayer generally does realize income if the taxpayer’s debt is discharged without payment. Internal Revenue Code Section 61(a)(12) (gross income includes “[i]ncome from discharge of indebtedness.” (Unless otherwise noted, references to “Code Sections” are to sections of the federal Internal Revenue Code of 1986, as amended.)
Therefore, a taxpayer’s relief when a creditor cancels or compromises a debt is often not complete. Unless an exception applies, the taxpayer will have ordinary income in the amount of the debt relief.
Federal Taxation Continued
Exceptions:
Fortunately for taxpayers, there are many exceptions to the rule that income from the discharge of indebtedness (or as it is more commonly called, or cancellation of debt) is subject to tax. Some of the exceptions to cancellation of debt income are judicial exceptions, but most of the exceptions are statutory exclusions from gross income or statutory measures of cancellation of debt income and are found in Code Section 108.
Federal Taxation Continued
Exception for Certain Discharged Student Loans:
The American Rescue Plan Act of 2021 (ARPA), was enacted on March 11, 2021, to provide further relief to Americans impacted by COVID-19. The $1.9 trillion stimulus package extended relief previously provided under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 and the Consolidated Appropriations Act of 2021, and included several new provisions designed to speed up the economic recovery from the pandemic.
A provision of the ARPA modified the treatment of student loan forgiveness under Code Section 108(f), excluding from gross income discharges occurring during calendar years 2021 through 2025 for certain educational expenses.
Federal Taxation Continued
(f) Student loans
(5) Special rule for discharges in 2021 through 2025 Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) after December 31, 2020, and before January 1, 2026, of—
(A) any loan provided expressly for postsecondary educational expenses, regardless of whether provided through the educational institution or directly to the borrower, if such loan was made, insured, or guaranteed by—
(i) the United States, or an instrumentality or agency thereof,
(ii) a State, territory, or possession of the United States, or the District of Columbia, or any political subdivision thereof, or
(iii) an eligible educational institution (as defined in section 25A),
(B) any private education loan (as defined in section 140(a)(7) [1] of the Truth in Lending Act),
(C) any loan made by any educational organization described in section 170(b)(1)(A)(ii) if such loan is made—
(i) pursuant to an agreement with any entity described in subparagraph (A) or any private education [2] lender (as defined in section 140(a) of the Truth in Lending Act) under which the funds from which the loan was made were provided to such educational organization, or . . . .
Federal Taxation Continued
Mechanics of the Discharge, No IRS Form 1099-Cs:
On December 21, 2021, the IRS issued an advance version of Notice 2022-1, notifying lenders of student loans that they “should not file information returns or furnish payee statements…to report the discharge of student loans when the discharge is excluded from gross income under Code Section 108(f)(5).” Thus, Form 1099-C is not required for student loan forgiveness occurring under ARPA for calendar years 2021 through 2025.
Federal Taxation Continued
Takeaway:
Within the parameters set out by the Biden Administration’s Executive Order and those embodied in Section 108(f)(5), a student loan forgiven under the Biden Administration’s Student Loan Debt Relief Plan is not taxable income and therefore doesn’t need to be included on a taxpayer’s Federal Income Tax Return.
Public Service Loan Forgiveness Program and Income Driven Repayment
What about PSLF and Income Driven Repayment?
Borrowers who are employed by non-profits, the military, or federal, state, Tribal, or local government may be eligible to have all of their student loans forgiven through the Public Service Loan Forgiveness (PSLF) program. This is because of time-limited changes that waive certain eligibility criteria in the PSLF program. These temporary changes expire on October 31, 2022. For more information on eligibility and requirements, go to PSLF.gov.
Note that this is not the same as forgiven student loans under federal income-driven repayment plans. Such plans base monthly student loan payments on family size and income for affordability.
When a borrower reaches the end of an income-driven repayment plan, any balance is forgiven, but it is subject to taxes.
North Carolina’s Taxation of Student Loans Forgiven Under the Biden Administration's Student Loan Debt Relief Plan
Conformity:
On November 18, 2021, Governor Roy Cooper (D) signed into law the 2021 Appropriations Act (2021–2022 N.C. Sess. Laws, ch. SL 2021-180, Senate Bill 105) (Bill), which affected various North Carolina taxes.
Tax provisions in the Bill are generally effective for tax years beginning January 1, 2022 and the Bill updated North Carolina's conformity to the Internal Revenue Code of 1986, as amended, to that in effect as of April 1, 2021 (from May 1, 2020). However, there are exceptions.
North Carolina Taxation Continued
Decoupling (exceptions):
The Bill decoupled the exclusion from income for the discharge of a student loans under the American Rescue Plan Act of 2021.
N.C. Gen. Stat. § 105-153.5(c2)(22) now provides:
(c2) Decoupling Adjustments. - In calculating North Carolina taxable income, a taxpayer must make the following adjustments to the taxpayer’s [federal] adjusted gross income: . . .
(22) For taxable years 2021 through 2025, a taxpayer must add the amount excluded from the taxpayer's gross income for the discharge of a student loan under section 108(f)(5) of the Code. The purpose of this subdivision is to decouple from the exclusion from income for [sic] the discharge of a student loan under section 9675 of the American Rescue Plan Act of 2021.
North Carolina Taxation Continued
STATEMENT OF NORTH CAROLINA DEPARTMENT OF REVENUE
North Carolina Taxation Continued
Takeaway:
Currently, North Carolina treats a student loan forgiven under the Biden Administration’s Student Loan Debt Relief Plan that is excluded from Federal income under Code Section 108(f)(5), as income for state tax purposes.
Filing 2022 Income Tax Returns
Issues?
North Carolina taxpayers shouldn’t have any problems filing a Federal Income Tax Return because of a student loan forgiven under the Biden Administration’s Student Loan Debt Relief Plan that is excluded from Federal income under Code Section 108(f)(5).
However, because it is unlikely a Form 1099-C will be issued to North Carolina taxpayers, complying with North Carolina tax law may be difficult.
Filing 2022 Income Tax Returns
Exceptions Other Than Code Section 108(f)(5)?
Insolvency: A taxpayer is insolvent when his or her total liabilities exceed his or her total assets.
Filing 2022 Income Tax Returns
26 U.S. Code § 108 - Income from discharge of indebtedness
(a) Exclusion from gross income
(1) In general Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if—
(A) the discharge occurs in a title 11 case,
(B) the discharge occurs when the taxpayer is insolvent,
(C) the indebtedness discharged is qualified farm indebtedness,
(D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or
(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged—(i) before January 1, 2026, or (ii) subject to an arrangement that is entered into and evidenced in writing before January 1, 2026.
(2) Coordination of exclusions
(3) Insolvency exclusion limited to amount of insolvency In the case of a discharge to which paragraph (1)(B) applies, the amount excluded under paragraph (1)(B) shall not exceed the amount by which the taxpayer is insolvent.
Filing 2022 Income Tax Returns
Filing 2022 Income Tax Returns
Caution:
My analysis should not be construed as tax advice. While this presentation represents my best interpretation of how North Carolina is likely to treat student loan debt cancelled under the Biden Administration’s Student Loan Debt Relief Plan as of today, nothing in this presentation should be relied upon for tax purposes. Affected taxpayers should consult with a tax preparer.
Arthur Bartlett�arthurb@charlottelegaladvocacy.org�www.charlottelegaladvocacy.org
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