Student Loan Forgiveness and Your Taxes


student loan forgiveness and your taxes (1)

You may have heard the ruckus about student loan forgiveness. If you have student loan debt, you may be eligible for some forgiveness. Here is the breakdown.

Student loan forgiveness is part of a three-part plan to help people with student debt affected by economic and pandemic conditions. The plan includes:

  • Debt forgiveness and a final extension of the pandemic pause on student loan repayment
  • A proposed rule modification for income-driven payment plans and the Public Service Loan Forgiveness program (PSLF)
  • Help with future college costs, such as increasing the maximum available Pell Grant

These changes concern federal student loans. Loans from banks and elsewhere are governed by the lending entity.

You need to know a few things before jumping in. Do you qualify, and how much do you owe? Will debt forgiveness be counted as income for taxation purposes? Do you need to fill out endless applications? 

Let’s dig in.

Qualification and Forgiveness

So, who qualifies, and how much debt does the plan forgive? These go hand in hand and apply to low and middle-income families.

If you did not receive a Pell Grant, your individual income is less than $125,000, or if you're married and filing jointly with an income up to $250,000, the program forgives up to $10,000 in student loan debt.

If you did receive a Pell Grant and meet the same income criteria above, the program forgives up to $20,000.

You may qualify for total debt forgiveness if you work for a nonprofit, are in the military, or work in federal, state, tribal, or local government now through October 31, 2022. Student loan forgiveness extends to parents who took out qualifying loans for their children's education.


Canceled Debt and Taxable Income

Under the American Rescue Plan Act (ARPA), forgiveness of student loan debt from 2021 through 2025 does not count toward your federal taxable income. If you have forgiven student loan debt, it won’t impact your refund or cause you to owe more taxes. 

State taxes, on the other hand, depend on the state where you live - and it gets complicated. Much depends on whether your state decided to align with the federal rules and how many of the rules they align with.

There are six dependencies having to do with state alignment to federal student loan forgiveness and state tax law. Of course, if you live in a state with no income tax, yay for you. You can skip to the next part.

You are exempt from taxes if your state:

  • Fully conforms to the current Internal Revenue Code (IRC) and ARPA
  • Doesn’t fully conform to the current IRC but follows the relevant ARPA provision
  • Doesn’t fully conform to the current IRC but separately excludes student debt cancellation

You are taxed if your state:

  • Fully conforms to the current IRC but doesn’t follow ARPA
  • Conforms to a pre-ARPA version of the IRC
  • Selectively conforms to the IRC or adopts an independent definition of income

So far, the following states may tax your student loan debt forgiveness windfall

  • Arkansas
  • California
  • Indiana
  • Minnesota
  • Mississippi
  • North Caroline
  • Wisconsin

This list may change. Always check the current law in your state.

Application or No Application?

There are 43 million borrowers eligible for student loan debt relief. Around 8 million will receive it automatically because all their information is available in the system. No application needed.

In early October, you can provide information on a simple online form through the Department of Education website. If you need to know your adjusted gross income, check your Form 1040 Line 11.

Employment Repayment Assistance

Did you work for a company that provided student loan repayment assistance through the CARES Act? If so, it’s unclear what impact ARPA will have on your employer or you.

Some employers used the CARES Act to contribute money toward their employees' federal or private student loans. They could contribute $5250 annually directly and tax-free to employee student loans extended through 2025.

Employer repayment is considered a form of debt forgiveness, typically taxable unless a law exempts it — like the student loan forgiveness provision. If the repayment doesn't fall under ARPA, you may be taxed on what your employer gave you.


I Defaulted on My Student Loan -- Now What

Would you believe one-third of student loan borrowers have already defaulted? Some of them have defaulted more than once. However, during the pandemic, many were able to have their good standing reinstated. 

Unfortunately, with inflation on the rise and the potential for a recession, it’s hard to know whether the student loan debt relief translates into fewer defaults. Before default relief, the penalties for defaulting were considerable:

  • It created significant negatives on your credit rating
  • The lender may have garnished your wages
  • The feds could seize any refunds and potentially some portions of specific tax credits

With the current economic uncertainty, if you think you might default, contact the US Department of Education or your loan servicer to find out about available loan rehabilitation programs. Don't wait until your credit ratings take a huge hit.

BTW - What Is Income-Driven Payment?

Oh, dear, we did mention that. Income-driven payment programs are designed to make your loan repayment more manageable. These programs reduce the amount you had to pay if you were a low or middle-income borrower, meaning:

  • You paid no more than 5% of your discretionary income for undergraduate student loans, reduced from 10%.
  • The amount of non-discretionary income rose.
  • Loan balances after 10 years were eligible for forgiveness if your original loan balance was $12,000 or less.
  • The plan covered unpaid monthly interest.

Also, there is the student loan interest deduction. This year (2022), if your modified adjusted gross income is less than $70,000 for a single filer or $145,000 for married filing jointly, you could deduct the amount you paid from your taxes, or you can deduct $2,500, whichever is less. 

Bottom Line

Not everyone qualifies for student loan debt forgiveness, and there’s no guarantee the plan will apply past 2025. However, if you meet the qualifications and receive student loan debt forgiveness, the IRS will not consider the forgiven debt as taxable income.

If you’re puzzled, contact Top Tax Defenders. We can answer all your questions.

New call-to-action