How Does Student Loan Forgiveness Impact Your Taxes?

President Biden’s sweeping federal student loan forgiveness program might be on hold, but that doesn’t mean your chances of having your student loan debt canceled are slim to none. Many student loan forgiveness programs are still available, including income-driven repayment plans, public service loan forgiveness, teacher loan forgiveness, and the borrower defense loan discharge program. You may still be wondering how this student loan forgiveness can impact your taxes.

If you’re considering one of these programs, you may wonder about the impact of student loan forgiveness on your taxes. So let’s look at how federal student loan forgiveness impacts your taxes so you know what to expect when you file your returns.

Is student loan forgiveness taxable?

Typically, the Internal Revenue Service (IRS) considers any kind of debt forgiveness to be taxable income. For example, if you owe $10,000 to your credit card company and they agree to settle your balance for $6,000, the remaining balance of $4,000 would be taxable income. The creditor would send you a Form 1099-C showing the forgiven debt, and you would report it on your federal income tax return.

Fortunately for federal student loan borrowers, there are several exceptions to this rule. The American Rescue Plan of 2021 made student loan forgiveness tax-free through 2025. So if you have student debt discharged through the public service loan forgiveness program or another program, you don’t have to pay federal income taxes on your forgiven student debt—at least for the next couple of years.

After 2025, the tax impact of loan forgiveness depends on the program. Because these loan forgiveness programs were created separately at different times, different rules apply.

For example, public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs, and the National Health Service Corps Loan Repayment Program aren’t taxable. On the other hand, if your loan was discharged under the closed school program or after completing an income-contingent repayment or income-based repayment plan, any debt forgiven is taxable income.

What about state income taxes?

You may not need to worry about being taxed on student loan forgiveness by the federal government, but state income taxes are another story.

While some states make exceptions for forgiven student loan debt, others do tax student loan forgiveness. If you file a state income tax return in one of the following states, you may have to pay taxes on your forgiven loan balance:

  • Arkansas
  • California
  • Indiana
  • Minnesota
  • Mississippi
  • North Carolina
  • Wisconsin

Of course, federal and state tax rules can change quickly. So it’s a good idea to work with a tax preparer who understands state law and can help you calculate your tax burden.

How Much Tax Will You Owe on Canceled Debt?

If your canceled debt is taxable, the amount of income tax you’ll owe depends on your tax bracket.

For example, let’s say you’re a single person with taxable income of $100,000 per year, putting you in the 24% tax bracket. In 2023, you have $20,000 of taxable debt forgiveness, which increases your federal taxable income to $120,000. You’re still in the 24% tax bracket—the loan cancellation didn’t push you into a higher tax bracket. So your tax bill on the student loan cancellation would be $4,800.

So you can see that tax-exempt student debt forgiveness can offer significant tax savings.

How to report student loan forgiveness on your federal taxes

Typically, when a loan is forgiven, the lender will issue a 1099-C. Then you report that amount as other income on Schedule 1 attached to your Form 1040.

You typically won’t receive a 1099-C for non-taxable forgiven debt. If you do receive a 1099-C for canceled federal student loans that you thought weren’t taxable, be sure to discuss the situation with your tax preparer.

There are several other exceptions to having debt cancellation considered taxable income, and your tax preparer can help you file Form 982 to report the exclusion.

You don’t have to worry about owing federal income taxes on your student loan debt forgiveness—at least for now. However, if you’re unsure whether your student debt relief falls into this category, please reach out. We can help clarify things for you.

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