Taxes on Forgiven Student Loans: What to Know

 July 27, 2021
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Taxes on forgiven student loans have long been the norm, with the IRS treating canceled debt as income. But borrowers won’t have to worry about facing a hefty tax bill until after 2025, thanks to a coronavirus relief package passed by Congress.

Still, it’s good to know about taxes on forgiven student loans, particularly if your state income taxes remain affected, or if you’re planning to pursue relief that won’t be delivered until 2026 or later. Here’s what to know:

Federal income taxes on forgiven student loans paused through 2025

Past efforts, such as the Underwater Student Borrowers Act, did little to protect borrowers from sometimes unseemly taxes on forgiven student loans. That all changed with student loan stimulus relief passed by Congress in March 2021. The American Rescue Plan Act made federal, private and institutional student loan forgiveness tax-free through 2025.

The Democratic senators who led the way for this provision estimated that borrowers with $50,000 in income would save about $2,200 in taxes for every $10,000 in forgiven student loan debt.

Previously, only loans forgiven through Public Service Loan Forgiveness, Teacher Loan Forgiveness and the National Health Service Corps Loan Repayment Program were exempt from being taxed, in addition to loans discharged if the student borrower becomes permanently disabled or dies.

For other types of debt cancellation, some borrowers attempted to claim insolvency to avoid paying taxes on forgiven student loans (more on that below).

It’s crucial to understand tax laws will revert on Jan. 1, 2026, so that you can avoid major surprises in the future.

What to expect with taxes on forgiven student loans

For many borrowers, income-driven repayment plans, such as Pay as You Earn, coupled with student loan forgiveness, can be financial saviors. These repayment plans cap your student loan payments each month at 10% to 20% of your income.

After 20 to 25 years of steady repayment, your remaining balance is forgiven.

However, there is an important factor to consider: Any loans forgiven under these programs would typically be considered taxable income by the IRS, which means that you could face a hefty tax bill when your loans are forgiven. For example, after making payments under income-based repayment for 20 years, you’re left with $40,000 in debt. That $40,000 in forgiven debt could be considered taxable income.

In this case, your lender could send you a Form 1099-C stating the amount of debt forgiven, which you’ll note when completing necessary tax forms like Form 1040.

So, though you may not have to pay $40,000 in student loans, you would still have a hefty tax bill. That $40,000 in loan forgiveness could bump your federal tax bill by thousands or tens of thousands of dollars — and that’s not accounting for potential state income taxes.

Watch out for state taxes on forgiven student loans
Although some states (such as Minnesota) have eliminated their tax bomb and others (such as Florida, Nevada and New Hampshire) don’t collect state income taxes, the amount you may end up paying is still significant. Contact your state’s tax agency via the

Let’s say you’re filing your taxes as an individual. Your taxable income (not including loan forgiveness) is $50,000. Here’s your estimated income taxes:

Income by Tax Bracket Tax Rate Estimated Income Taxes
$9,700 10% $970
$29,775 12% $3,573
$10,525 22% $2,316

In this scenario, your total estimated income taxes would be $6,859 — at an effective tax rate of 13.72%.

Now let’s include the $40,000 in loan forgiveness. With your taxable income at $90,000, here’s a look at the estimated income taxes:

Income by Tax Bracket Tax Rate Estimated Income Taxes
$9,700 10% $970
$29,775 12% $3,573
$44,725 22% $9,840
$5,800 24% $1,392

In this scenario, your total estimated income taxes would be $15,775 — at an effective tax rate of 17.53%. By having $40,000 in loans forgiven, your tax bomb would be $8,916. If you have more taxable income and a larger amount of loans are forgiven, you can see that your income taxes would rise pretty drastically.

If you can’t pay your tax bill, you’d be forced to set up a payment plan with the IRS to make payments toward your tax debt. If you don’t take any action, you could face a penalty and have to pay interest on this debt.

‘Insolvency student loan forgiveness’ and taxes

When student loans are forgiven, you’re issued a Form 1099-C, which shows the amount of forgiven debt to be included as income. But there is an exception called insolvency student loan forgiveness for people who are considered to be “insolvent.”

Insolvency is a tax situation in which your total liabilities are more than your total assets. If you are insolvent immediately before your loans are forgiven, there may be a way to lower your tax bill.

Let’s run through some examples.

When you don’t have to pay taxes on forgiven student loans Let’s say Zack has $3,000 in the bank, $10,000 in retirement savings and a car worth $5,000, so his assets total to $18,000. He also has $15,000 in credit card debt, a $5,000 auto loan and $20,000 in student loans, so his total liabilities are $40,000. His current net worth is his assets ($18,000) minus his liabilities ($40,000), giving him a negative net worth of -$22,000.
If his student loans of $20,000 are forgiven, he is still insolvent with a net worth of -$2,000. In this case, because Zack is insolvent both before and after the loan forgiveness, he is off the hook and does not have to pay any federal income taxes on his student loan forgiveness balance.
When you have to pay partial taxes on forgiven student loans Wendy has $40,000 in assets and $60,000 in liabilities, of which $30,000 is student loans. Before her student loans are forgiven, Wendy is insolvent by $20,000, but after the loans are forgiven, she has a positive net worth of $10,000. If her loans are forgiven, her solvency position changes from -$20,000 to +$10,000. The “income” on the starting insolvent position is not taxable, but the remaining $10,000 is taxable.
When you have to pay full taxes on forgiven student loans Vanessa has $300,000 in assets and $150,000 in liabilities, of which $75,000 are student loans. Because she is solvent both before and after her $75,000 student loans are forgiven, the entire $75,000 in student loan balance is taxable.

Consult an expert if you pursue student loan forgiveness

As you can see from the insolvency student loan forgiveness examples, the tax situation is complicated. If you are in a position to get your student loans forgiven, you could end up with a massive tax bill from your state, or from the federal government after 2025. The deciding factor is your net worth and how much is being forgiven.

To make sure you are on the up-and-up with your state’s tax authority and the IRS, you’d be best served by working with a tax expert. A trip to the accountant might sound expensive, but it could save you thousands in taxes on forgiven student loans. That’s an investment well worth the cost.

Andrew Pentis, Larissa Runkle, Eric Rosenberg and Sage Evans contributed to this report.