While President Joe Biden's ambitious student loan forgiveness plan faced a setback from the Supreme Court, the Biden administration has managed to alleviate federal loan burdens for millions of borrowers through alternative means. For many, this relief comes as a tax-free benefit from the federal government. However, depending on their state of residence, borrowers may find themselves owing taxes at the state level.
Traditionally, forgiven federal student loan debt under specific programs, such as income-driven repayment (IDR) plans, is considered taxable income. This means that borrowers receiving such relief could expect a higher tax liability. However, a temporary change occurred due to the American Rescue Plan enacted during the COVID-19 pandemic. This legislation exempted federal student loan debt canceled between 2021 and the end of 2025 from being counted as taxable income at the federal level.
This exemption could result in significant savings for borrowers, particularly for those concerned about facing a hefty tax bill as a result of student loan forgiveness. For example, if a borrower with a median U.S. household income of around $75,000 had $20,000 in loans forgiven, under normal circumstances, their taxable income would increase to approximately $95,000. With the forgiven amount falling within the 22% tax bracket for an individual, this could result in a tax bill of $4,400. However, the actual amount owed would vary based on individual circumstances such as deductions, credits, and other sources of income.
While most states are following the federal government's lead in not taxing forgiven debt, there are five states—Arkansas, Indiana, Mississippi, North Carolina, and Wisconsin—that currently impose taxes on forgiven student loan debt. Therefore, borrowers residing in these states who received student loan forgiveness may face taxable income at the state level when filing their 2023 returns.
Given the complexity and evolving nature of tax laws, it's advisable for borrowers who have benefited from loan forgiveness to consult with a tax professional. Typically, borrowers who receive forgiveness are provided with a 1099-C tax form to report to the IRS.
Since taking office, President Biden's Education Department has forgiven $138 billion in student loans for 3.9 million borrowers, utilizing a combination of existing forgiveness programs like IDR and PSLF, as well as discharging debt for disabled individuals and victims of institutional fraud.
In addition to these measures, President Biden has introduced a new, more generous IDR plan named SAVE, which has attracted 7.5 million enrollees, with 4.3 million paying nothing per month towards their loans, according to the Education Department.
Further relief may be forthcoming, as the administration works on proposed regulations to expand eligibility for loan forgiveness, following the Supreme Court's rejection of Biden's initial forgiveness plan.
