Student loan forgiveness has been a hot topic in the U.S. for the past year, as millions of borrowers have benefited from various debt relief programs initiated by the Biden administration. However, as tax season approaches, many borrowers may wonder if they have to pay taxes on their forgiven student loans.
The answer is not so simple, as it depends on the type of loan forgiveness, the source of the loan, and the state where the borrower lives. Here are some key details to know.
Federal Student Loan Forgiveness Is Tax-Free Until 2025
Under the American Rescue Plan Act of 2021, any federal student loan forgiveness, cancellation, or discharge that occurs between January 1, 2021 and December 31, 2025 is not taxable at the federal level. This means that borrowers who qualify for programs such as Public Service Loan Forgiveness (PSLF), Borrower Defense to Repayment, or Teacher Loan Forgiveness will not have to report their forgiven debt as income on their federal tax returns.
This also applies to borrowers who have their loans forgiven under the Limited PSLF Waiver, which allows borrowers who were in the wrong repayment plan to get credit for their payments and potentially receive forgiveness. The Biden administration has issued over $24 billion in student loan forgiveness under this waiver alone.
Private Student Loan Forgiveness May Be Taxable
However, not all student loan forgiveness is tax-free. Private student loans, which are issued by banks and other lenders, are not covered by the American Rescue Plan Act. This means that if a borrower has a private student loan forgiven, cancelled, or discharged, they may receive a Form 1099-C from their lender and have to report the amount as income on their federal tax return.
There are some exceptions to this rule, such as if the borrower can prove that they were insolvent at the time of the cancellation or if the debt was discharged in bankruptcy. However, these situations may require additional documentation and professional guidance.
State Taxes May Vary Depending on Where You Live
Another factor that may affect the taxability of student loan forgiveness is the state where the borrower lives. While most states follow the federal tax code and do not tax federal student loan forgiveness, there are some states that have decided to tax it at the state level.
According to a report by Tax Foundation, a nonpartisan tax policy think tank, Indiana, Mississippi, North Carolina and Wisconsin will tax the amount of federal student loan forgiveness as income at the state level. Arkansas is still deciding whether it will impose taxes on debt cancellation.
Borrowers who live in these states should consult with a tax advisor or preparer to figure out how this can affect their state taxes and plan accordingly. They should also keep an eye out for any changes in state legislation that may affect their tax situation.
How to Prepare for Tax Season If You Have Student Loan Forgiveness
If you have received or expect to receive any form of student loan forgiveness, cancellation, or discharge in 2023, you should be prepared for tax season and avoid any surprises. Here are some tips to help you:
- Keep track of your student loan statements and correspondence from your servicer or lender. You may need these documents to verify your loan balance and payments.
- Check your mail or email for any Form 1099-C that you may receive from your servicer or lender. This form will show the amount of your cancelled debt and the date of cancellation. You may need this form to file your federal and state tax returns.
- Review your federal and state tax laws and rules regarding student loan forgiveness. You can use online resources such as IRS.gov or your state’s department of revenue website to find information and guidance. You can also use online calculators or software to estimate your tax liability.
- Seek professional help if you are unsure or have questions about your tax situation. You can contact a certified public accountant (CPA), an enrolled agent (EA), or a tax attorney who can advise you on your specific case and help you file your tax returns correctly.
- Save money for any potential tax bill that you may owe. If you have to pay taxes on your forgiven student loans, you should set aside some money in advance to avoid penalties and interest. You can also explore payment plans or options with the IRS or your state if you cannot pay your taxes in full.