Government's plans for taxing student loan forgiveness explained - essential facts to consider
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Starting in 2026, Student Loan Forgiveness under Income-Driven Repayment Plans will be Taxable
As of January 1, 2026, the Internal Revenue Service (IRS) will consider forgiveness of student loan debt under income-driven repayment (IDR) plans as taxable income. This means that borrowers whose loans are forgiven after 20, 25, or 30 years on these plans will owe federal income tax on the forgiven amount.
Under the current rules, cancellation of debt is treated as income by the IRS, and this taxability returns after a tax exemption on forgiven student debt enacted by the American Rescue Plan Act expires on December 31, 2025.
To reduce or avoid potential tax liability associated with IDR forgiveness after 2025, borrowers can consider the following strategies:
- Time forgiveness before the end of 2025: If your loan forgiveness can occur before January 1, 2026, the forgiven amount is tax-free due to the current exemption. This may involve verifying your number of qualifying payments, resolving any discrepancies promptly, and possibly accelerating or managing repayments to hit forgiveness in 2025 rather than later.
- Confirm your forgiveness effective date: Some borrowers have reported the Department of Education backdates forgiveness to the date of their final qualifying payment rather than the official processing date, which could help avoid taxes if this practice continues.
- Consolidate loans wisely: Loan consolidation can affect eligibility for forgiveness and tax treatment, so careful planning and consultation with an expert may help preserve tax benefits.
- Consult a tax advisor: Because state tax treatment varies and policies may evolve, seeking personalized guidance tailored to your situation is recommended for tax planning and to maximize benefits.
- Plan repayment strategy with new plans: The transition from current IDR plans (SAVE, PAYE, IBR, ICR) to the Repayment Assistance Plan (RAP) by July 2028, which features a longer 30-year forgiveness timeline, may impact when and how your loan may be forgiven and taxed. Adjusting your repayment approach accordingly is important.
In summary, after 2025, forgiven amounts under income-driven repayment plans will most likely be taxable income, increasing borrowers’ tax bills. Borrowers should proactively manage repayment timelines to obtain forgiveness before the end of 2025, track payments accurately, consider loan consolidation effects, and seek tax advice to minimise or avoid tax burdens.
It's worth noting that other types of student loan forgiveness and discharge, such as Bankruptcy Discharge of Student Loans, are tax-free. Additionally, if the taxpayer is insolvent, the IRS may waive the tax liability.
As federal student loan programs continue to evolve, it's crucial for borrowers to stay up to date with trends that will impact their student loans.
[1] Internal Revenue Service. (n.d.). Cancellation of debt (COD) income. Retrieved from https://www.irs.gov/taxtopics/tc468 [2] Department of Education. (n.d.). Income-driven repayment plans. Retrieved from https://studentaid.gov/manage-loans/repayment/plans [3] Federal Student Aid. (n.d.). Loan forgiveness and discharge. Retrieved from https://studentaid.gov/manage-loans/forgiveness-cancellation [4] Congressional Research Service. (2021, June 8). Federal student loan forgiveness: Overview and options. Retrieved from https://crsreports.congress.gov/product/pdf/R/R46823
- Managing personal-finance and career-development strategies is crucial for students with education-and-self-development loans, as they need to be aware of the upcoming taxability of student loan forgiveness under income-driven repayment plans starting from 2026, which may increase their financial burden.
- To optimize personal-finance outcomes and minimize taxes on student loan forgiveness, it's recommended that borrowers explore options such as accelerating payments to achieve forgiveness before 2026, seeking advice from tax professionals, and staying informed about changes in federal student loan programs.
