The business of student loan forgiveness: The American Rescue Plan and business taxes
As a small business owner, every dollar counts. That includes the ones you make or are given. In cases where a debt is forgiven, it can be tricky to figure out how this might affect your business cash flow.
The announcement of student loan debt forgiveness may have brought some worry. How does this affect my income? Will this contribute to me paying more money in taxes? Will it be counted as income for my business?
The bottom line of your business flows into your personal income, and that can shift your entire tax plan. So we'll help you clear up some confusion around how student loan forgiveness could affect your taxable income.
| For student loan debt forgiveness, tax compliance is in the details.
Will this affect business taxable income?
As a general rule, a discharge of indebtedness counts as income and is taxable. Normally, if your student loan debt was canceled, you would owe taxes on the amount that was canceled.
That means as a sole proprietor or single member LLC, the amount of the debt that was canceled would combine with your gross income, and you would have to pay taxes on the total amount. So basically, when it comes to debt cancellation, you would have to look at it through two lenses: the business side and the personal side.
On the business side
Student loan debt forgiveness that is being introduced under the American Rescue Plan has no direct effect on business income because the federal government decided that it was not a taxable event under the ARPA.
Remember, just this particular student loan debt forgiveness, any other debt cancellation is typically taxable and would have the ability to increase your adjusted gross income.
On the personal side
If you are a sole proprietor or single member LLC, you know that your business income flows to your personal return. Normally, debt forgiveness would impact your personal income and you may owe taxes on that forgiven debt, but student loan debt forgiveness under the American Rescue Plan does not count towards federal taxable income.
Therefore, on the business and personal side of things, federally, there would be no impact on your taxes.
But wait, there's more...
Even though the federal government decided student loan debt forgiveness would not be taxable, states can make this debt taxable. If that occurs, you may owe more taxes than you had planned.
States could decide to treat student loan debt in six different ways:
- Conform to the current version of the IRC with ARPA (exempt)
- Conform to the current version of the IRC but decouple from ARPA (taxable)
- Not fully conform to the current IRC but bring in the relevant ARPA provision (exempt)
- Not fully conform to the current IRC but separately exclude student debt cancellation (exempt)
- Conform to a pre-ARPA version of the IRC (taxable)
- Selectively conform to the IRC or adopt an independent definition of income (taxable)
If your state decides not to conform to the ARPA, that means your debt would be taxable, which could cause your tax bill to be higher than desired.
So what now?
Stay up-to-date with reliable resources, including studentaid.gov. Follow any required directions to apply for loan debt forgiveness or other repayment plans. Usually, the IRS sends borrowers Form 1099-C for any debt of $600 or more that had been canceled. However, this practice is typically only required for taxable canceled debt, so these forms, or similar documents, may not be used.
Check with your loan servicer to be sure the forgiven amount isn’t reported as taxable. A mismatch could cause a headache at tax time. You might also want to check if the amount forgiven will affect any deduction you expect to take on interest payments.
States are slowly releasing guidance, but be sure to check with your state's revenue departments in the coming weeks to make sure you won't be getting a tax bill that you weren't prepared to pay.
Don’t lose sight of your business taxes
Business tax can be complicated, and changing regulations and new circumstances like the recent American Rescue Plan can leave business owners a little lost. That is why you shouldn’t wait until the end of the year or for tax season to start planning and budgeting for taxes. Instead, start early.
By leaning on business tax resources and beginning your preparation and planning early in the year, you can create a strategy to make taxes more manageable. Begin implementing budgeting software, track deadlines, and research potential deductions to maximize the amount of money you and your business can save.
Be sure to also check out our webinar, Make it Easier: Tax & Legal Building Blocks for Entrepreneurs, for more insight into navigating your business's legal and tax jargon. And if you need help managing your tax deadlines, notices & more? We’ve got you covered. Try us for free.