Student Loan Discharges: What You Need to Know About Taxes

Student Loan Discharges

Many borrowers in income-driven repayment (IDR) plans are finally receiving student loan forgiveness after years—often decades—of payments. This relief can be life-changing, especially for borrowers with large balances and limited savings. But there is one important issue to understand: depending on when the forgiveness happens, the forgiven amount may be treated as taxable income.

A recent letter from the U.S. Senate to the Treasury Department and IRS raised concerns that borrowers could face unexpected tax bills after receiving forgiveness. If the forgiven amount becomes taxable, some borrowers could owe thousands of dollars in federal taxes.

How IDR Forgiveness Works

IDR plans base your monthly student loan payment on your income and family size. After you make qualifying payments for:

• 20 years (for undergraduate loans), or

• 25 years (for graduate or older loans),

any remaining balance can be forgiven.

Recent government data shows the average amount forgiven is about $49,000. Most borrowers receiving forgiveness have less than $10,000 in savings, which is why understanding the tax impact is so important.

Why Taxes Matter

Federal tax law generally treats cancelled or forgiven debt as taxable income unless a specific exclusion applies. Through the end of 2025, most student loan forgiveness is excluded from taxable income. After that, unless new laws are passed, forgiven student loan amounts may once again be taxable.

What could this mean? Senate analysis provided examples:

• A married taxpayer with two children earning $50,000 could owe almost $9,000 in additional federal tax if their IDR forgiveness is taxable.

• A taxpayer earning $40,000 could owe more than $10,000 because the increase in income affects eligibility for tax credits.

For borrowers with limited savings, this surprise tax bill could be a serious financial challenge.

Possible Ways to Avoid Tax on the Forgiven Amount

The Senate has asked the IRS to clarify whether existing tax exclusions might apply. These are not automatic — but they may help certain borrowers.

Insolvency exclusion

You may avoid tax on forgiven debt to the extent your total debts are greater than your total assets immediately before the forgiveness. This requires a detailed calculation and supporting records.

Scholarship exclusion

Some lawmakers argued that IDR forgiveness is similar to a need-based educational benefit. This is not current law, but new guidance could potentially change this in the future.

General welfare exclusion

This applies to certain government payments based on financial need. The Senate believes IDR forgiveness fits this definition, but the IRS has never applied this exclusion to loan forgiveness. Further guidance would be required.

What Borrowers Should Do Now

If you have received or expect to receive student loan forgiveness, there are several steps you can take to prepare.

Find out whether you’re affected Ask your loan servicer whether you are in an IDR plan and whether a forgiveness adjustment is pending. Some borrowers receive discharge letters without understanding the tax impact.

Keep all documentation Save:

• payment history

• discharge notices

• any Form 1099-C (Cancellation of Debt)

These documents are essential to determine whether any exclusions may apply.

Understand how forgiveness affects your tax return

Forgiven debt may increase your adjusted gross income (AGI), which can reduce or eliminate tax credits and increase overall tax liability.

Consider potential exclusionsIf your forgiveness happens after 2025 and becomes taxable, review whether the insolvency exclusion applies. Timing matters — insolvency must be calculated immediately before the forgiveness.

Plan ahead for filingIf forgiveness happens late in the year, you may need to adjust estimated tax payments or prepare for a higher amount due at tax time.

Check state tax rules

Some states follow federal law on student loan forgiveness; others may tax the forgiven amount even if the federal government does not.

Common Mistakes to Avoid

• Assuming all student loan forgiveness is tax-free

• Forgetting that higher AGI may reduce eligibility for credits

• Missing a Form 1099-C issued through an online loan portal

• Not documenting assets and debts before forgiveness

• Not staying updated — guidance may change as new rules are released

A Changing Landscape

Student loan forgiveness is evolving, and millions of borrowers will be affected in the coming years. Understanding the potential tax impact is essential so you can plan, avoid surprises, and make informed decisions.

If you receive a discharge or expect one soon, reach out to your tax professional. They can help you understand the rules, explore possible exclusions, and prepare for how forgiveness may affect your financial situation and tax return.

Student Loan Discharges: What You Need to Know About Taxes - Thank you NATP Staff