Are Forgiven Student Loans Taxed?
With some exceptions, the IRS has historically treated forgiven student debt as taxable income. That, however, is not the case with Biden’s one-time student loan relief plan, should it pass current court challenges. (The case is now with the Supreme Court; a decision is expected in June.)
The reason the one-time, Covid-19-related forgiveness (of up to $20,000) wouldn’t be federally taxed? Five words: the American Rescue Plan Act. Passed in March 2021, the law specifies that student loan debt discharged between 2021 and through 2025 and incurred for postsecondary education expenses will not be counted as income, and therefore would not incur a federal tax liability.
That said, some states have indicated that they will still count canceled student loans as taxable income. Read on for more information about which discharged student debt is taxable and by whom.
Different Student Loan Forgiveness Programs
In addition to the president’s one-time, Covid-related debt cancellation plan, whose fate is with the Supreme Court, federal student debt can be canceled via an income-driven repayment plan or forgiveness programs.
For example, the Department of Education (ED) recently amended the Public Service Loan Forgiveness Program (PSLF) and the “borrower defense to repayment” program, and as a result, it has erased $7.3 billion in student loans for nonprofit and government employees who have remaining debt after 10 years or 120 payments and $7.9 billion for 690,000 borrowers whose education provider deceived them “or engaged in other misconduct in violation of certain state laws,” according to the ED’s Federal Student Aid office.
Also, during the current administration, the ED has been forgiving the student debt of certain borrowers: $3.9 billion for 208,000 students who attended ITT Technical Institute, a now-closed for-profit school; $5.8 billion for all former students of Corinthian Colleges, another shuttered, for-profit school; and more than $8.5 billion for 400,000 borrowers with a total and permanent disability.
Recommended: Guide to Student Loan Forgiveness
Whose Student Loan Cancellation Is Not Federally Taxed?
As stated earlier, under the provisions of the American Rescue Plan Act, any student debt (private or federal) for post-secondary education that was or is forgiven in the years of 2021 through 2025 will not be federally taxed. This means that the borrowers just listed above were not required to report their discharged loan amount as earned, and therefore taxable, income.
If Biden’s Covid-related student debt relief program survives the legal battle, recipients of that debt cancellation would also not be required to report their debt discharge as taxable income.
Outside of the special five-year window of tax exemption provided by the American Rescue Plan, participants of the PSLF program who receive forgiveness also don’t have to worry about paying taxes on the canceled amount. The program explicitly states that earned forgiveness through PSLF is not considered taxable income.
Whose Student Loan Cancellation Is Federally Taxed?
Typically, borrowers who receive loan cancellation after participating fully in an income-driven repayment plan can generally expect to pay taxes. Again, those whose debt was discharged in 2021 and 2022, or will be discharged in 2023, 2024, or 2025, will not need to pay federal taxes on their forgiven loans.
Forgiven amounts that are taxable are treated as earned income during the fiscal year it was received. Your lender might issue tax Form 1099-C to denote your debt cancellation.
💡 Quick Tip: Some student loan refinance lenders offer no fees, saving borrowers money. (Please note that refinancing student loans means losing access to federal protections and repayment programs.)
Which States Have Said They Will Tax Forgiven Student Loans?
Typically, states follow the tax policy of the federal government. But according to the Tax Policy Center, these six states have either indicated that they will tax discharged education debt or have laws on the books that don’t exempt forgiven student debt from taxes: Indiana, Minnesota, Mississippi, North Carolina, Wisconsin, and California. Additionally, the Arkansas legislature has yet to decide whether it will tax forgiven student loans.
In case you are wondering, only one of the states that have legally challenged the Biden forgiveness plan overlaps with states that will or may tax forgiven student loans: Arkansas. The other state plaintiffs in a case currently with the Supreme Court conform with the current federal definitions of taxable income, again, according to the Tax Policy Center: Nebraska, Missouri, Iowa, Kansas, and South Carolina.
Preparing to Pay Discharged Student Loan Taxes
If you’re anticipating a tax liability after receiving loan forgiveness, there are a few steps you can take today to get ready.
Step 1: Estimate Your Bill
The first step when bracing for a student loan forgiveness tax bill is calculating how much you might owe come tax season. This factor can be influenced by factors including the type of forgiveness you are receiving and the forgiven amount.
To avoid sticker shock, you can use a student loan forgiveness tax calculator, like the Loan Simulator on StudentAid.gov. It lets you see how much of your student loan debt might be forgiven, based on your projected earnings.
Step 2: Choose the Right Plan
Enrolling your federal student loans into an income-driven repayment (IDR) plan can help you keep your monthly payments to a manageable amount while you’re awaiting loan forgiveness. There are four IDR plans available: Pay As You Earn, Revised Pay As You Earn, Income-Contingent Repayment, and Income-Based Repayment.
All of these repayment plans calculate your monthly payment, based on your income and family size. Depending on your situation, you might be eligible for a $0 monthly payment.
Recommended: REPAYE vs PAYE: What’s the Difference?
Step 3: Prioritize Saving
If you’re expecting loan forgiveness after 2025, it might be advantageous to allocate extra cash flow toward a dedicated tax savings fund. Incrementally setting money aside over multiple years can ease the burden of a sudden lump sum tax bill down the line.
Paying Taxes on Canceled Student Loan
If you can’t afford to cover an increased tax bill, contact the IRS to discuss your options. Inquire about payment plans that can help you pay smaller tax payments over a longer period of time. However, be aware that fees and interest will likely accrue.
💡 Quick Tip: Refinancing could be a great choice for working graduates who have higher-interest graduate PLUS loans, Direct Unsubsidized Loans, and/or private loans.
Thanks to a special law passed by Congress in 2021, post-secondary education loans forgiven from 2021 through 2025 will not count as earned income and will not be federally taxed. That said, state taxes may be due, depending on where the borrower lives.
Is loan repayment considered taxable income?
If your employer offers loan repayment assistance benefits, they would typically be considered taxable income. However under the Cares Act, loan forgiveness payments — and employer assistance loan payments up to $5,250 — made each year from 2021 through 2025 are tax-free.
Will refinancing my student loans help me avoid taxes?
Student loan refinancing simply involves reworking one or more existing student loans into a new private loan with more favorable terms. It’s a repayment strategy that does not incur a tax liability.
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SoFi Student Loan Refinance
If you are looking to refinance federal student loans, please be aware that the White House has announced up to $20,000 of student loan forgiveness for Pell Grant recipients and $10,000 for qualifying borrowers whose student loans are federally held. Additionally, the federal student loan payment pause and interest holiday has been extended beyond December 31, 2022. Please carefully consider these changes before refinancing federally held loans with SoFi, since the amount or portion of your federal student debt that you refinance will no longer qualify for the federal loan payment suspension, interest waiver, or any other current or future benefits applicable to federal loans. If you qualify for federal student loan forgiveness and still wish to refinance, leave unrefinanced the amount you expect to be forgiven to receive your federal benefit.
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Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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