Since March 13, 2020, many people with federal student loans did not have to worry about making payments. The U.S. Department of Education stopped the payments, set interest to 0%, and millions hoped that President Biden’s plan to forgive some debt would help them.
But things changed again. In October 2023, borrowers had to start making payments again. Then, in February 2024, the Biden administration canceled about $1.2 billion in loans for 153,000 people on the Saving on a Valuable Education (SAVE) repayment plan.
In late March 2024, another update came. The Biden administration approved debt cancellation for more than 78,000 borrowers who work in public service jobs. These include teachers, nurses, firefighters, social workers, and members of the military. In this round, a total of $5.8 billion in student loan debt was forgiven. Since October 2021, the Public Service Loan Forgiveness (PSLF) program has helped 871,000 borrowers by canceling $62.5 billion in debt.
Even though these changes bring good news, getting rid of your student loan debt is not always a simple break. Some types of loan forgiveness may lead to a tax bill later on. This unexpected cost is sometimes called the “student loan tax bomb.”
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Do I Have to Pay Income Taxes on Student Loan Forgiveness?
The IRS says that if a debt is canceled, it is usually treated like extra income. This means you might have to pay federal income taxes on it. For a while, the American Rescue Plan Act of 2021 made it so that forgiven student loans did not count as income. This rule applies to loans discharged from January 1, 2021, to December 31, 2025. Some states also follow this rule, but not every state does. For example, Indiana, North Carolina, Mississippi, and Wisconsin have decided to tax the forgiven amounts. Arkansas and California are still deciding what to do.
What Happens After 2025?
After December 31, 2025, the tax rules for student loan forgiveness might change. How much tax you pay depends on the type of forgiveness program you use. Here are some of the programs:
Public Service Loan Forgiveness (PSLF)
- Who qualifies: People who work full-time for a government agency, nonprofit, or other public service group.
- How it works: After 10 years and 120 qualifying monthly payments, the remaining loan balance is canceled.
- Tax rule: The forgiven amount is not taxed as income.
Income-Driven Repayment (IDR) Discharge
IDR plans help borrowers who have trouble paying their regular loans. The monthly payments are based on how much money you make. The four IDR plans are:
- Income-Based Repayment (IBR)
- Income-Contingent Repayment (ICR)
- Pay As You Earn (PAYE)
- Saving on a Valuable Education (SAVE; formerly REPAYE)
For these plans, if you still owe money at the end of the loan term, the remaining balance is forgiven. However, this forgiven debt is treated as taxable income at both the federal and state levels.
Borrower Defense to Repayment Discharge
If a college did not tell the truth about its programs or broke state laws, borrowers might get their loans discharged through this program. The IRS and the U.S. Department of the Treasury say that the forgiven loans in this case are not counted as taxable income.
Total and Permanent Disability Discharge (TPDD)
This program is for borrowers who become totally and permanently disabled. How the tax is handled depends on when you got your discharge:
- Before January 1, 2018: The discharged loan was taxable.
- Between January 1, 2021, and December 31, 2025: The forgiven debt is not taxed.
- After 2025: It is not clear yet what will happen.
What About Private Student Loans?
Private student loans are different. They do not qualify for federal programs like PSLF or TPDD. However, some private lenders may forgive loans if you become totally and permanently disabled. The American Rescue Plan also covers private loans through the end of 2025, making them tax-free for now. After 2025, state taxes might still apply.
Frequently Asked Questions
Can I pay down my balance to lower my tax bill?
Yes, you can pay down your loan balance if you expect the remaining debt to be forgiven after 2025. But keep in mind, if your payments are based on your income, your future payments might increase if you lower the balance.
How can I guess how much I will owe in taxes because of student loan forgiveness?
The amount you pay depends on how much debt is forgiven and your tax bracket. You can use tools like the American Institute of CPAs marginal tax rate calculator to get a rough idea of your tax bill. Saving money regularly in a high-yield savings account or a CD can help you be ready for any tax bill.
What if Congress extends the American Rescue Plan?
If Congress decides to extend the plan beyond 2025, borrowers using IDR, TPDD, or private loan forgiveness programs would continue to be tax-free at the federal level. Remember, PSLF is already tax-free, so it would not change.
This article explains student loan forgiveness in simple language, so you understand how it works and what you might owe in taxes. It is important to stay updated with any changes in laws and rules. If you are unsure about your situation, consider talking to a financial expert or tax professional.