Taxes On Student Loan Forgiveness Programs: What To Know

Taxes On Student Loan Forgiveness Programs: What To Know

Student loan forgiveness has long been subject to taxation, with the IRS classifying canceled debt as income. However, because of the coronavirus relief package passed by Congress, you won’t have to worry about a significant tax charge until after 2025.

Even so, it’s essential to understand the tax implications of forgiven student debts, especially if you seek student loan forgiveness that won’t occur until 2026 or later or if your state income taxes are still affected.

Here’s what you need to know.

The Tax Treatment On Student Loan Forgiveness

The IRS informed student loan lenders in 2021 that they no longer needed to send out Form 1099-C, Cancellation of Debt, to borrowers who had paid off their loans.

The borrower usually receives a copy of this form after it’s been filed with the Internal Revenue Service and sent to them. This was a massive departure from when you had to pay income taxes on this sum.

However, this change doesn’t guarantee that you’ll never have to pay taxes again. How much of your forgiven debt is subject to taxation as earned income is determined by the program you’re eligible for and the timing of the forgiveness.

Student Debt Forgiveness Is Exempt From Federal Income Taxes Until 2025

Underwater Student Borrowers Act attempts have done nothing to protect borrowers from excessive taxes on student loans that are forgiven. However, everything changed when Congress passed a student debt stimulus bill in March 2021.

The American Rescue Plan Act extended tax-free loan forgiveness for private, federal, and institutional loans through 2025.

Democratic senators who spearheaded this proposal predicted that borrowers with $50,000 in income would save $2,200 for every $10,000 of forgiven student loan debt.

Only Government Programs Were Free From Taxes

It used to be the case that only loans were forgiven through government programs such as Teacher Loan Forgiveness, Public Service Loan Forgiveness, and the National Health Service CLRP were free from taxes.

Tax regulations will revert on January 1, 2026, so it’s important to know what to expect in the future.

Loan Programs And Taxes At The State Level

State loan repayment assistance and forgiveness programs exist in addition to federal loan forgiveness programs. Some programs are tax-free, but not all are; it all depends on how they’re set up.

If you’re participating in a state forgiveness program, you should seek advice from a tax professional to avoid any unpleasant surprises.

Private Student Loan Forgiveness

PSLF isn’t available to students with private loans, but there are specific circumstances in which they can be forgiven privately. For example, some lenders may grant a discharge if there is a complete and irreversible impairment.

After 2025, the American Recovery and Reinvestment Act expressly excludes discharged private student loans from income tax.

Income-Driven Repayment Plan (IDR) And Taxes

Loan forgiveness may be available after 20 or 25 years, depending on your IDR plan. The remaining balance is canceled after completing an IDR plan for the required period.

That could have been a problem in the past. However, with an IDR plan, borrowers would be taxed on the amount of debt forgiven.

However, the American Recovery Act exempts IDR plan forgiveness from taxation through 2025.

Seek Professional Advice If You Want Student Loan Forgiveness

The tax situation is tricky, as the examples of insolvency loan forgiveness show. However, after 2025, if you can have your student loans forgiven, you may face a massive tax obligation from your state or the federal government.

The amount that’s forgiven and your net worth will determine the outcome.

Working with a tax specialist is the best way to ensure you’re on the right track with your state’s tax authority and the IRS.

A trip to the accountant may appear costly, but it may save you hundreds of dollars in taxes on forgiven student loans. That is a wise investment.

Final Thoughts

Even though forgiveness programs are available, only a small percentage of borrowers will be eligible. However, because most borrowers are ineligible for forgiveness, you won’t have to worry about a forgiven loan sum being taxable as income.

Another option if you have graduate or undergraduate loans and want to pay them off quickly is refinance your debt. You might be eligible for a lower rate, allowing you to save money and pay off your debt faster.