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Is Student Loan Forgiveness Taxable?

Last month, the Biden administration fulfilled its campaign promise when it announced that it would be canceling student loan debt for millions of borrowers. It’s estimated that about 43 million people will benefit from the student loan forgiveness plan with nearly half having their debt completely canceled. This is in addition to the $26 billion already approved through existing relief programs where rules were either expanded or relaxed to make forgiveness easier. If you’re one of the many who will see their student loan debt diminish or disappear, you may be wondering, “Is student loan forgiveness taxable?” It’s a good question to ask considering tax season is right around the corner. For most, there will likely be no tax liability. There are, however, several factors to consider and where you live could complicate matters.   

Student Loan Forgiveness & Federal Taxes

Generally, when you have a debt canceled or forgiven, you’ll pay federal taxes. This is because the debt has gone from being a loan to essentially income that must be reported on your tax return. If it’s a large amount that’s canceled, your tax liability could be substantial. In terms of student loan forgiveness, however, the rules vary depending on the program.

Public Service Loan Forgiveness (PLSF)

Since its creation in 2007, Public Service Loan Forgiveness (PSLF) has always been non-taxable under federal law. This includes the new Limited PSLF Waiver Program which makes it easier for more people to qualify and get relief.

Total and Permanent Disability (TPD) Discharge

The Total and Permanent Disability (TPD) Program, which has undergone some recent changes, was not exempt from taxes until a few years ago. Noting that those receiving forgiveness under TPD were already struggling financially, Congress passed a law in 2017 making TPD exempt from taxes through 2025.

Borrower Defense to Repayment Program

Borrowers who attended schools that misled them or engaged in deceptive conduct can seek relief under the Borrower Defense to Repayment Program. This year, the U.S. Department of Education (ED) has approved claims against several colleges, including:

In most cases, borrowers will have their loans discharged without needing to take any additional action. The IRS has also taken the position that loans discharged under “Defense to Repayment” are never taxable.

Other Federal Programs – Tax Relief Through 2025

Thanks to the American Rescue Plan Act of 2021, all federal student loan forgiveness and cancelation are temporarily exempt from taxation through 2025. This includes the recently announced Student Debt Relief Plan which allows up to $10,000 in federal student loan cancelation for borrowers making less than $125,000 ($250,000 if married) or up to $20,000 for Pell Grant recipients.

Private Student Loans

If you are one of the few people who have had private student loan debt canceled or forgiven, the unfortunate news is that it may still be taxable. At this time, the IRS has not made statements or provided any guidance related to the taxability of this type of student loan debt. Unless advised by a tax professional to so otherwise, assume that you’ll need to include any canceled private student loan debt as income on your tax return.

State Tax Liability

Although the federal government has taken to steps to ensure borrowers are not hit with a big tax bill, there are a few states that may attempt to collect taxes. For example, Mississippi, Minnesota, Wisconsin, Arkansas, and Kansas all treat forgiven student loans as taxable income. If they don’t change their laws to mirror the federal tax exemption, borrowers in those states could receive larger tax bills next year. Other states, such as New York and Pennsylvania, have already indicated that they will follow federal guidelines and not tax any student loans forgiven under Biden’s program. Those who live in Florida and other states with similar tax structures don’t need to worry since they don’t pay state income taxes anyway.

Need Help?

If you receive student loan forgiveness or cancelation in 2022, be sure to check with your state’s Department of Revenue to determine your income tax liability before filing your returns next year. It’s also a good idea to consult with a tax professional if you have any additional questions related to student loan forgiveness and taxes. For a free consultation, call Tax Defense Network at 855-476-6920.