Forgiveness of student loans can feel like hitting the winning numbers on a lottery draw. One day you owe tens of thousands of dollars: the next day it’s gone. A weight lifted off your shoulders. However, depending on the type of loan and timing of forgiveness, a federal tax obligation may still be waiting. It’s important to understand how this works, so you’re prepared for whatever may come.
Why Loan Forgiveness Can Trigger a Tax
When a loan is cancelled, the IRS may view the forgiven amount as taxable income. In effect, if you borrow a sum and that debt is later wiped out, the tax code can interpret that as a financial gain rather than a cost. Unless the law designates the forgiven debt as tax‑exempt, you may need to report it. Loan forgiveness comes in two layers:
- Direct tax cost, federal and possible state income tax on the forgiven amount
- Indirect cost, higher Adjusted Gross Income, that can reduce credits and deductions, such as reduced child tax credit, earned income credit, etc.
What’s Tax‑Free Right Now
Under current federal legislation, most federal student loan forgiveness is not taxable through December 31, 2025. That exemption covers situations such as:
- Discharges due to death or total and permanent disability
- Cancellation under income‑driven repayment (IDR) plans after 20 or 25 years
Congress did not extend American Rescue Plan Act of 2021, which provides loan forgiveness. Therefore, after 2025, some of these forgiveness types may become taxable again.
What Happens When Forgiveness Becomes Taxable
If the exemption ends and your debt is forgiven, here’s how it could play out:
- You might receive Form 1099‑C (Cancellation of Debt) from your loan servicer, which shows the forgiven amount.
- That amount typically must be included as “other income” on your federal return for the year it’s forgiven.
- The tax you owe will depend on your tax bracket, not on the entire forgiven sum.
For example: if your remaining balance of $70,000 is forgiven and you fall into the 22% bracket, you could owe around $15,400 in federal tax. There may be additional state tax as well as reduced credit from the higher AGI.
What Remains Tax‑Exempt
Some programs remain excluded from taxable income regardless of timing:
- Public Service Loan Forgiveness (PSLF) for qualifying public service occupations
- Perkins Loan cancellations for eligible service fields like education or healthcare
- Borrower‑defense discharges tied to school closures, false certification or unpaid refunds
Already Taxable Forgiveness Types
Certain loan cancellations are taxable now and not dependent on the 2025 expiration, including:
- Employer student‑loan repayment assistance (LRAPs) under certain structures
- Similar federal government repayment assistance outside exempt programs
Options When You Can’t Cover the Tax Bill
If you face a tax liability you cannot handle immediately, federal tax rules allow for:
- Insolvency exclusion: Forgiven debt may be excluded from income if your total liabilities exceed your assets at the time of forgiveness.
- Offer in compromise: You may be able to negotiate with the IRS to settle for less than you owe, via Form 656.
- Installment agreement: Form 9465 allows payment of tax liability over time (up to six years in some cases).
Keep in mind that refinancing federal loans into private ones may offer a lower interest rate, but it can mean losing access to certain federal forgiveness or repayment programs, which could affect the tax outcome.
Looking Ahead
If your loan is likely to be forgiven in 2026 or later, this moment is one to watch closely. Ask yourself, what will this cost me in taxes and when? Know your forgiveness type, while paying close attention to the calendar. Set aside savings as you approach your forgiveness date. Stay up to date with policy changes. For many borrowers, the real problem is not just getting the loan forgiven; it is surviving the tax burden in the end.
If you need further guidance or have any questions on this topic, we are here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
