What the New Student Loan Forgiveness Tax Break Means for BorrowersApril 9, 2021
Updated May 4, 2022
In March, President Biden signed the American Rescue Plan — a massive bill designed to provide people with relief during the COVID-19 pandemic — into law. While the bill mainly provided Americans with financial relief in the form of another round of stimulus checks, it included a small provision that benefits student loan borrowers: it modified how taxes on student loan forgiveness programs are handled.
Here is how the American Rescue Plan affects student loan forgiveness and how you might benefit from this change.
How the stimulus package impacts student loans
Besides stimulus checks, the American Rescue Plan also expanded unemployment benefits and provided employers with tax credits for offering emergency paid leave. With such major changes, adjustments to how student loan forgiveness programs are taxes didn’t get a lot of press. But for qualifying borrowers, the modifications can be significant.
Currently, borrowers who qualify for certain student loan forgiveness programs have to pay income taxes on the forgiven amount. For those who have a large balance that is discharged, that can mean coming up with thousands to satisfy the tax bill.
The American Rescue Plan changes that. It creates special rules for discharges completed in 2021 through 2025. Under the new rules, borrowers’ gross income does not include the forgiven amount, helping to reduce their tax bills.
Who benefits from the student loan forgiveness bill in 2021?
Notably, the American Rescue Plan specifically calls out several types of loans that would fall under the new loan forgiveness rules:
- Federal loans, including FFEL, Perkins, and Direct Loans
- State-issued loans
- Institutional loans provided by schools
- Private student loans
Why is that so important? As conversations continue around student loan forgiveness, Biden is paving the way to provide relief to borrowers who may qualify for future discharge efforts.
In the past, Biden has discussed forgiving $10,000 in student loans for federal loan borrowers. However, other Democrats have lobbied for up to $50,000 in loan forgiveness and have demanded relief for private loan borrowers, too.
Thanks to the American Rescue Plan, borrowers with federal or private student loans won’t have to worry about paying income taxes on the forgiven loan amount.
What programs are affected by the American Rescue Plan?
Not all forgiveness and loan discharge programs result in taxes; only certain programs consider the forgiven amount taxable as income.
If you are enrolled in an income-driven repayment plan and your loan balance is discharged after 20 to 25 years of making payments, the forgiven amount is taxable. There are four different income-driven repayment plans you may be on:
- Income-Based Repayment
- Income-Contingent Repayment
- Pay As You Earn
- Revised Pay As You Earn
If you have loans forgiven and the discharged amount is taxable as income, your loan servicer will send you a 1099-C: Cancellation of Debt Form. This form lists how much of your debt was discharged.
Loan forgiveness programs that aren’t taxed
If you qualify for loan forgiveness or discharge through the following programs, you won’t have to pay income taxes on the discharged balance even after the American Rescue Plan’s provisions expire:
- Public Service Loan Forgiveness
- Total and Permanent Disability Discharge
- Perkins Loan Cancellation
- Borrower Defense to Discharge
How much can borrowers save?
When thinking about how much you can save with the American Rescue Plan, it’s important to consider what forgiveness or discharge program you’re eligible for, your income, and your marginal tax rate.
For example, let’s say Jason has $100,000 in outstanding student loans and earns $60,000 per year. At that income level, his marginal tax rate is 22%. For the 2020 tax year, Jason owes $6,262 in federal taxes.
However, if all of his remaining loan balance is forgiven, then his taxable income for the year would increase to $160,000, and his marginal tax rate would increase to 24%. Since his marginal tax rate jumped up so much and he has a higher taxable income, he would pay much more in taxes. For the 2020 tax year, he’d owe the IRS $29,504 — a difference of over $20,000.
If you aren’t prepared for that kind of tax bill, you may be able to enter into a payment plan with the IRS. However, the IRS’ payment plans require you to pay setup fees and interest, costing you even more money.
When does the tax modification end?
The American Rescue Plan’s impact on student loan forgiveness and taxes isn’t permanent, and it doesn’t apply to all borrowers; it’s a temporary measure aimed to give relief to borrowers during the pandemic.
The waiver of taxes on forgiven student loans only applies to loans discharged after December 31, 2020, and before January 1, 2026. If your loans are discharged before or after those dates, you will still owe income taxes on the forgiven loan balance.
Taxes and student loans
If you have student loans and your balance will be forgiven after the American Rescue Plan’s provisions expire, it’s important to plan ahead:
- Estimate the discharged amount: You can use the U.S. Department of Education’s repayment estimator tool to calculate your loan forgiveness amount. Based on the amount, you can figure out how much you’d likely pay in taxes.
- Save money: Start tucking money away into a separate savings account to prepare for your future tax bill. By setting aside a little every month, you can avoid a major shock — and financial burden — once your loans are forgiven.
- Consult a tax professional: If you’re worried about how loan forgiveness could affect your taxes, it’s a good idea to consult with a tax professional. They can help you prepare your tax return and plan for your future tax bill if you qualify for loan forgiveness. You can use CPAPowered to find a licensed, certified public accountant (CPA) in your area.