Student Loan Forgiveness Tax Implications

Student loan forgiveness cancels your student loan debt—or what’s remaining. While this certainly comes with significant financial benefits, it also has an often unexpected side effect: higher taxes.

That’s only in some cases, though. If you think you may be eligible to have your student loans forgiven, use this guide to determine its impact on your tax returns (and how to prepare for it).

Is student loan forgiveness taxable?

According to the IRS, canceled or forgiven debt is usually considered taxable income. In the past, some federal student loan forgiveness programs have been exempt from federal income taxes—particularly those that require a work or service obligation. 

The American Rescue Plan Act (ARPA) of 2021 extended that exemption to all student loan forgiveness programs through 2025. During that time, lenders and loan servicers , the IRS, or your state’s tax agency won’t send you a 1099-C form. Lenders typically provide this form when discharging or canceling a debt so that you can report the amount as income on your tax return.

However, after the 2025 tax year, it’s unclear whether the federal tax exemption for federal student loan forgiveness programs will continue.

However, some states, including Indiana, North Carolina, Mississippi, and Wisconsin, will continue to treat forgiven student loan balances as taxable income and apply it to state income tax. Legislators in Arkansas are still determining whether or not to align with the ARPA.

What is a ‘student loan forgiveness tax bomb?’

A student loan forgiveness tax bomb occurs when you qualify for student loan forgiveness and must pay taxes on the discharged balance. Additionally, because the forgiven amount could result in a significant jump in income for the borrower, it could also push them into a higher tax bracket, resulting in a higher effective (average) tax rate. 

However, through the 2025 tax year, student loan borrowers won’t experience a federal student loan forgiveness tax bomb, regardless of which program they qualify for.  Keep in mind that you may still be subject to state income taxes with specific forgiveness programs. Consult with a tax professional to get an idea of what to expect. 

How much will you owe in taxes from forgiveness?

Since there’s no federal income tax on student loan forgiveness through the 2025 tax year, you may only need to worry about state income taxes on your balance. That said, you may need to pay state income tax, depending on where you live, your income, and which program you benefited from. 

Here’s an estimate of what you can expect if you earn $60,000 in income and receive $10,000 in forgiveness in 2023 under a program that’s not exempt from taxation in your state. Note, the tax due calculations are based on the $10,000, not the entire income:

• Arkansas: Arkansas has a progressive income tax rate, ranging from 2% to 4.7%. If your taxable income exceeds $24,300 without adding in the discharged amount, you’d owe state taxes in the amount of $470. If your income falls below that mark, your tax bill may be less.

• Indiana: The Hoosier state has a flat income tax rate of 3.23%, regardless of your income. So, you can expect to pay $323 in state income taxes on that amount. 

• North Carolina: There’s a flat income tax rate of 4.75% in North Carolina, resulting in a $475 tax bill.
  
• Mississippi: The Magnolia state assesses a 5% income tax on all income above $10,000. If your income exceeds that threshold without adding back the forgiven amount, you owe $500 on the discharged amount. If your income falls below that mark, you may owe less.
  
• Wisconsin: Wisconsin has a progressive tax system, with rates ranging from 3.54% to 7.65%. Whether you’re a single or married filer, your tax rate on the forgiven amount would likely be 5.3%, resulting in a $530 bill.

Keep in mind that these are estimates. Be sure to consult a tax professional for state-specific tax advice.

How to prepare for student loan forgiveness taxes

If you don’t live in a state that taxes federal student loan forgiveness, you can rest assured that you won’t have to deal with a student loan forgiveness tax bomb.

However, if you live in one of the states that plan to tax student loan forgiveness programs currently exempt from federal taxes, use your state’s tax rate to estimate what you can expect to pay. Then, consider these steps:

• Start saving: Set aside a small portion of your monthly paychecks in a high-yield savings account.
• Switch to a different repayment plan: For example, the SAVE—or Saving on a Valuable Education plan—reduces your monthly payment to 10% of your discretionary income (dropping to 5% in Summer 2024), and if your payment isn’t enough to cover your accruing interest, that unpaid interest won’t be added to your balance, potentially reducing the forgiven amount.
• Work with a tax advisor: If you don’t already have one, find a tax advisor who can provide guidance on how to prepare for your student loan forgiveness tax bomb and also look for opportunities to reduce your taxable income with certain deductions and write-offs.

Resources on tax policy 

The American Rescue Plan created a federal tax exemption on all forgiven student loans through 2025. There’s no telling if the pause will continue once 2026 rolls around, but the current administration has made other significant improvements to student loan forgiveness programs.

Examples include one-time adjustments to accelerate forgiveness for eligible borrowers in the PSLF program and on income-driven repayment plans and introducing a new income-driven repayment plan with a shorter forgiveness timeframe. 

President Biden has also instructed the Department of Education to initiate a rulemaking process that could create an alternative path to widespread student loan forgiveness after his administration’s plan to provide up to $20,000 in forgiveness was struck down by the Supreme Court. 

To get the latest information on student loan forgiveness and potential tax implications in the long term, subscribe to the Department of Education’s email list.