The idea of student loan forgiveness has caught the attention of many borrowers and sparked lots of discussions. If you're wondering how this might affect your taxes, you're not alone. It's important to know the rules and potential tax implications that come with student loan forgiveness. This article will break down the current laws, potential tax liabilities, and key points to consider.
Legal Framework for Student Loan Forgiveness
Understanding the legal side of student loan forgiveness helps clarify why some states treat it differently. Key student loan legal authorities include the Higher Education Act of 1965,1 which provides the foundation for federal student loan programs; and the Public Service Loan Forgiveness (PSLF) program, established under the College Cost Reduction and Access Act of 2007,2 which offers forgiveness for those working in public service jobs. Additionally, the Internal Revenue Code (IRC) plays a crucial role in determining the tax treatment of forgiven student loans.
Federal Tax Treatment
Usually, forgiven debt is reported to the IRS on Form 1099-C3 and counts as taxable income (cancellation of debt income).4 This means that if a lender forgives a portion of your student loan, you would typically be required to report the forgiven amount as income on your federal tax return. However, there are notable exceptions to this general rule, including the American Rescue Plan Act of 2021 (ARPA).5 ARPA introduced significant changes, providing that any student loan forgiveness occurring between December 31, 2020, and January 1, 2026, is excluded from taxable income. This temporary relief applies to federal and private student loans, offering a crucial reprieve for borrowers during the specified period.
However, in Biden v. Nebraska,6 the U.S. Supreme Court addressed the Biden administration's student loan forgiveness program, which aimed to cancel significant federal student loan debt for eligible borrowers (those earning under a certain income threshold). The Court found that the states challenging the program (Nebraska, Missouri, Arkansas, Iowa, Kansas, and South Carolina) had standing to sue. It ruled that Biden’s administration lacked the authority under the HEROES Act7 to implement such a broad forgiveness program. The decision underscored the limits of executive power in modifying or waiving student loan obligations without clear congressional authorization. As a result, the proposed student loan forgiveness program was struck down, affecting millions of borrowers who had hoped for debt relief.
Following the U.S. Supreme Court's 2023 decision to strike down President Biden’s student loan forgiveness program, he has announced new measures, including an income-driven repayment plan that caps payments based on income and family size and forgives remaining balances after a set period.8 President Biden is also exploring alternative legal pathways for debt relief and remains committed to supporting borrowers within the constraints of the Court's ruling.
Income-Driven Repayment (IDR) Plans and Forgiveness
Income-driven repayment plans,9 such as Income-Based Repayment (IBR) and Pay As You Earn (PAYE), provide for loan forgiveness after 20 or 25 years of qualifying payments. While these plans offer long-term relief, the forgiven loan amount at the end of the repayment period is generally treated as taxable income under IRC § 61(a)(11). However, as previously mentioned, ARPA provides a temporary exclusion for forgiven student loan amounts from taxable income until January 1, 2026. Based on current law, loans forgiven after this temporary relief period will be taxable as cancellation of debt income.
Public Service Loan Forgiveness (PSLF), Loan Repayment Assistance Program (LRAP) and Taxation
The PSLF program offers loan forgiveness to borrowers who:
- work in qualifying public service jobs (such as government organizations, non-profit organizations under 501(c)(3), and other non-profit organizations that provide qualifying public services like public health, public education, and law enforcement); and
- make 120 qualifying monthly payments (i.e., 10 years of monthly payments).
Importantly, loan amounts forgiven under the PSLF program are not considered taxable income. The Internal Revenue Code specifically provides tax-free treatment for any student loan debt forgiven under the PSLF program. 10 Similarly, the IRS ruled that student loans forgiven under a Loan Repayment Assistance Program (LRAP) offered by law schools qualify as "student loans" for income exclusion from the discharge of indebtedness under IRC § 108(f), provided the loan terms require graduates to work in qualifying public service roles for a specified period before forgiveness.11 The ruling confirms that such LRAP loans, designed to encourage public service and refinanced by the educational institution, meet the necessary criteria for this tax exclusion.
Potential Future Changes
The future tax treatment of student loan forgiveness remains uncertain. Legislative proposals, such as the Student Loan Tax Relief Act, aim to make the tax-free treatment of forgiven student loans permanent. Additionally, ongoing discussions about broader student loan forgiveness initiatives could lead to further changes in the tax code. Borrowers should stay informed about legislative developments and consult tax professionals for the most current guidance.
State Tax Implications
While federal tax law provides a framework for the tax treatment of student loan forgiveness, state tax laws can vary. Some states conform to federal tax provisions, while others (such as Arkansas, North Carolina and Wisconsin) may not. For instance, while ARPA provides federal tax relief, certain states may still consider forgiven loan amounts as taxable income. Borrowers should review their state's tax laws or consult with a tax advisor to understand their state-specific implications. Get our free State Tax Student Loan Forgiveness Guide to learn more about state-specific rules.
Conclusion
Understanding the tax implications of student loan forgiveness is crucial for borrowers navigating their repayment options. The temporary relief provided by ARPA offers significant tax benefits, but it is essential to stay informed about potential legislative changes that could impact the future tax treatment of forgiven loans. Borrowers should also be mindful of state tax laws that may differ from federal provisions.
If you are considering student loan forgiveness or are uncertain about the tax implications of your repayment plan, seeking professional advice is highly recommended.
1Public Law 89-329, 79 Stat. 1219 (1965). The original Higher Education Act of 1965 was signed into law by President Lyndon B. Johnson on November 8, 1965.
2 Public Law 110-84, 121 Stat. 784 (2007); codified as 20 U.S.C. § 1087e(m).
3https://www.irs.gov/forms-pubs/about-form-1099-c
4https://www.govinfo.gov/content/pkg/USCODE-2023-title26/pdf/USCODE-2023-title26-subtitleA-chap1-subchapB-partI-sec61.pdf
5Public Law 117-2, 135 Stat. 4 (2021); codified as 26 U.S.C. § 108(f)(5). This section of the U.S. Code addresses the tax treatment of various forms of discharged debt, including student loans, and was amended by the ARPA to provide temporary tax relief for student loan forgiveness.
6https://taxladylawyer.com/wp-content/uploads/2024/07/Biden-v.-Nebraska-600-US-477.pdf
7Pub. L. No. 108-76, 117 Stat. 904 (2003); codified as amended at 20 U.S.C. §§ 1098aa-1098ee. The HEROES Act, or the "Higher Education Relief Opportunities for Students Act," is a federal law that grants the Secretary of Education the authority to waive or modify statutory and regulatory provisions applicable to federal student financial assistance programs. This authority can be used during times of national emergency to ensure that affected individuals are not placed in a worse financial position concerning their loans due to the emergency.
8Amy Howe, Supreme Court strikes down Biden student-loan forgiveness program, SCOTUSblog, (Jun 30 2023), https://www.scotusblog.com/2023/06/supreme-court-strikes-down-biden-student-loan-forgiveness-program/ (last visited July 25, 2024).
9See Office of Fed. Student Aid, U.S. Dep’t of Educ., Income-Driven Repayment Plans, https://studentaid.gov/manage-loans/repayment/plans/income-driven (last visited July 26, 2024).
10https://www.law.cornell.edu/uscode/text/26/108
11Rev. Rul. 2008-34, 2008-28 I.R.B. 76 (ruling that the LRAP, which aims to assist graduates working in public service roles by refinancing their original student loans, meets the criteria outlined in Section 108(f)(1) and (2)).
