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Over the last few months, the federal government has canceled billions of dollars in student loans and expanded options for more borrowers to have their student loan debt forgiven.
That’s good news for borrowers, but it could have consequences in the form of an unexpected tax bill for some.
Refinancing with a private student loan can be a way to lower student loan costs. Credible makes it easy to compare student loan refinance rates from multiple lenders.
The basics of student loan forgiveness
If you have federal student loans, you generally have several options for student loan forgiveness, including:
- Public Service Loan Forgiveness (PSLF), Teacher Loan Forgiveness, and Perkins Loan cancellation — If you work full-time in government, tax-exempt organizations, education, or other public-service professions, you may have federal Direct Loans forgiven under these programs.
- Closed school discharge — If your school closes while you’re enrolled or soon after withdrawing, you may be able to have your Direct Loans and FFEL Program loans discharged.
- Discharge due to death or total and permanent disability — If you’re a federal student loan borrower who dies or becomes disabled, you may qualify to have your federal loans discharged.
- Borrower Defense to Repayment — If your educational institution lied or misled you to get you to enroll, you may qualify to have your federal student loan debt discharged.
- Income-driven repayment — Some income-driven repayment plans allow you to have the remaining balance on your federal student loans forgiven after 20 or 25 years.
Recent changes in student loan forgiveness
Many of these student loan forgiveness programs have been around for years, but confusing eligibility requirements and errors by student loan servicers made it tough to achieve loan forgiveness.
Under President Joe Biden, the Department of Education has announced several initiatives designed to expand relief. Among those initiatives:
- Automatically canceling the remaining federal student loan balance for borrowers who previously had a portion of their loans canceled under the Borrower Defense to Repayment program
- Automatic federal student loan discharges for some former students of ITT Technical Institutes
- Significant changes to the PSLF program, designed to allow more borrowers to qualify for forgiveness
What this means for borrowers
While getting out from under a mountain of student loan debt will benefit many borrowers, anyone considering loan forgiveness should know that canceled debt might create a tax bomb.
Generally, when a creditor cancels a debt, the IRS considers that debt erasure to be taxable income. The creditor may send you Form 1099-C, Cancellation of Debt, showing the amount of debt discharged.
When might forgiven amounts be taxed?
All forms of student loan forgiveness are free from federal income taxes — at least for now. The American Rescue Plan Act provided tax-free student loan forgiveness for all loans canceled between Jan. 1, 2021, and Dec. 31, 2025.
That includes student loan debt forgiven under an income-driven repayment plan. Normally, the IRS treats any federal student loan debt forgiven at the end of the repayment plan as taxable gross income. Income-driven repayment plans that become eligible for forgiveness before Dec. 31, 2025, are not taxable. After that date, it could be taxable unless Congress extends the provision or makes it permanent.
Currently, the IRS also doesn’t tax cancellation of debt income for borrowers who have their student loan debt forgiven due to death or disability. This is also temporary.
This provision of the Tax Cuts and Jobs Act of 2017 (the law that made death and disability discharge a tax-free event) is scheduled to sunset at the end of 2025. Unless Congress renews the provision or makes it permanent, that scenario could become taxable in 2026.
When won’t you have to pay tax on forgiven amounts?
Outside of the temporary student loan tax relief mentioned above, some forms of student loan forgiveness aren’t taxable. This includes several federal student loan forgiveness programs, including:
- Public Service Loan Forgiveness
- Teacher Loan Forgiveness
- Perkins Loan cancellation
- Borrower Defense to Repayment
- Closed school discharge
What about state income taxes?
Every state has different laws regarding the taxability of canceled student loan debt. State taxability isn’t an issue if you live in one of the eight states with no state-level income tax (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming). Residents of New Hampshire also don’t have to worry about forgiven loans impacting their state taxes, since New Hampshire only taxes interest and dividend income.
If you live in one of the other 41 states, check with your state’s Department of Revenue or a qualified tax professional.
What to do if you can’t afford to pay your tax bill
If your canceled student loan debt is taxable and you can’t afford the tax hit, don’t panic. The IRS is generally willing to work with people who have trouble paying their tax bills.
Here are a few options:
- Short-term payment plan — If you can pay the balance due within 120 days, request a short-term payment plan at IRS.gov.
- Installment agreement — If you need more time, you can make monthly payments through an IRS installment agreement. Visit the IRS website to set up the payment plan.
- Personal loan — Penalties and interest can add up on an overdue tax bill. If you have good to excellent credit, it may be less costly in the long run to take out a personal loan to pay your tax obligation upfront.
Other ways to reduce student loan costs
If you don’t qualify for any of the student loan forgiveness programs outlined above, consider these options for reducing your student loan costs:
- Enroll in autopay. Many lenders offer a small discount on your interest rate if you enroll in autopay. This won’t reduce the loan’s principal balance, but it can reduce the total you’ll pay over time.
- Refinance with a private student loan. Refinancing may allow you to lower your loan’s interest rate. Or, if you refinance into a longer term, you could reduce your monthly payment amount — but will likely increase the total interest costs. Also, if you refinance federal student loans into a private student loan, you lose federal student loan benefits such as access to income-driven repayment plans.
Credible makes it easy to compare student loan refinance rates from multiple lenders.
About the author: Janet Berry-Johnson is an authority on income taxes and small business accounting. She was a CPA for over 12 years and has been a personal finance writer for more than five years. Janet has written for several well-known media outlets, including The New York Times, Forbes, Business Insider and Credit Karma. In 2021, Canopy named her one of the Top 10 Influential Women in Accounting and Tax.