Individuals who are in repayment, have been granted student loan forgiveness, or are currently on track for eventual discharge face a multitude of intricate rules, opportunities, exceptions, as well as potential pitfalls that they must navigate.
It is crucial to seek expert tax guidance from a qualified professional, like a Certified Public Accountant.
Guide for Student Loan Borrowers
State Taxation of Federal Student Loan Forgiveness
Most debt cancellations incur taxes. Form 1099-C requires borrowers to report forgiven debt as taxable income.
Current law exempts most federal student loan forgiveness programs from federal taxes until 2025. Federal taxes have never applied to Public Service Loan Forgiveness or Teacher Loan Forgiveness.
Some programs, like Income-Driven Repayment plans, are temporarily tax-exempt under the American Rescue Plan Act of 2021.
After 20 or 25 years of repayment, loan forgiveness is tax-free.
The Education department warns that some states may tax student loan forgiveness as taxable income, even though it is federally tax exempt.
Borrowers should consult a tax advisor about state tax obligations related to federal student loan forgiveness. State law violations can result in penalties.
Future Tax on Student Loan Forgiveness
The IDR Account Adjustment program may provide substantial retroactive loan forgiveness to borrowers who aren’t eligible for immediate relief.
This could reduce the time they have to repay their loan and speed up loan forgiveness.
After 2025, IDR loan forgiveness borrowers might encounter taxable discharges again. Congress may extend or permanently extend the federal tax exemption, which expires on January 1, 2026.
This offers a rare bipartisan opportunity. If this doesn’t happen, many borrowers may face large tax bills sooner than expected.
IDR payment counts should be monitored by student loan borrowers during the summer.
The Education Department plans to release these counts in July as part of the IDR Account Adjustment.
Formal IDR payment counts will help borrowers estimate when they will reach the 20- or 25-year student loan forgiveness milestone.
A tax or financial advisor should help borrowers plan for any taxes on the forgiven amount. Unexpected tax liabilities can have serious consequences if not prepared for.
Tax Implications of a Single Loan Forgiveness Program
The Total and Permanent Disability discharge program relieves federal student loan debt for medically disabled people who cannot work. Medically certified or Social Security disability recipients who receive TPD discharges will be monitored for three years.
If a borrower returns to school and takes out a new federal student loan, the forgiven loans could be reinstated.
People discharged from TPD in 2023 will not finish their three-year monitoring until 2026.
Individuals may receive a 1099-C in 2027 for tax year 2026 if Congress fails to extend temporary tax relief.
Other tax exemptions, such as insolvency, may exempt TPD discharge-eligible borrowers from paying taxes on their forgiven student loan balance.
However, 2023 and later TPD dischargees should consult their tax advisor. Failure to do so may result in unexpected future events.