Biden’s New Student Loan Forgiveness Changes May Wind Up Costing Some Borrowers

Biden’s New Student Loan Forgiveness Changes May Wind Up Costing Some Borrowers

The Biden administration is in the process of implementing significant new federal student loan forgiveness initiatives. These programs may ultimately help millions of borrowers get closer to having their student loans cancelled.

But depending on the specific program and the exact timing of that loan forgiveness, some borrowers may wind up getting hit with a surprise penalty: extra taxes.

Biden Makes Big Changes To Key Student Loan Forgiveness and Repayment Programs

In April, the Biden administration announced historic reforms to federal student loan income-driven repayment (IDR) programs, which include Income Based Repayment (IBR), Revised Pay As You Earn (REPAYE), and other plans. IDR plans allow federal student loan borrowers to make payments based on their income and family size. After 20 or 25 years in the program (depending on the specific plan), any remaining balance can be forgiven.

IDR plans have also been a required element of the Public Service Loan Forgiveness (PSLF) program, which can eliminate federal student loan debt for borrowers in as little a 10 years if they work in full-time careers for government agencies or nonprofit organizations. Last October, the Biden administration announced sweeping, temporary changes to the PSLF program, as well, called the “Limited PSLF Waiver” initiative.

Taken together, the Limited PSLF Waiver program and the temporary changes to IDR, which the administration is calling the “IDR Adjustment,” will allow the Department of Education to count many more loan periods towards student loan forgiveness under both IDR and PSLF, including:

  • Any past time period in which the borrower was in a “repayment status,” regardless of the type of repayment plan or the specifics of a particular payment;
  • 12 or more prior months of consecutive forbearance, or 36 or more months of cumulative forbearance;
  • Any prior months spent in deferment (with the exception of in-school deferment) before 2013; and
  • Periods of repayment prior to loan consolidation.

According to the Department of Education, “Any borrower with loans that have accumulated time in repayment of at least 20 or 25 years will see automatic forgiveness, even if you are not currently on an IDR plan.” The Department estimates that 40,000 borrowers could get their loans forgiven very quickly, while millions of additional borrowers could advance their progress towards eventual student loan forgiveness.

Some Borrowers May Be Taxed On Student Loan Forgiveness

Generally, whenever a debt (including a student loan) is reduced, waived, forgiven, or cancelled, the debtor or borrower may have to pay taxes on that cancelled balance. The lender would send the borrower a 1099-C form during tax time, which would show the amount of loan cancellation. The borrower may then have to report the cancelled debt on their tax return as “income,” leading to higher taxes. When large amounts of debt are cancelled, this can potentially result in significant tax liability for the borrower.

Certain types of student loan forgiveness are not taxable. Public Service Loan Forgiveness (PSLF) is not taxable under federal law, and that is also true for relief under the Limited PSLF Waiver. So those borrowers getting student loan forgivness under that program would not have to worry about federal taxation.

Loan forgiveness under IDR, however, is more complicated. This type of student loan forgiveness is generally taxable. However, the American Rescue Plan Act — the stimulus bill passed by Congress and signed by President Biden last year — temporarily exempts all federal student loan forgiveness from federal taxation through the end of 2025. That means that for borrowers expecting immediate or imminent student loan forgivness as a result of the new IDR Adjustment, they shouldn’t have to pay any federal income taxes.

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“The American Rescue Plan Act included a provision temporarily modifying the tax treatment of discharged student loan debt,” says the Department of Education in published guidance. “Specifically, the law excludes from gross income qualifying student loans that are discharged between December 31, 2020, and January 1, 2026. During this period, the amounts of forgiven student loan debt will not be subject to taxation.”

But borrowers who are able to gain years of progress towards loan forgiveness under the IDR Adjustment, but would still have some time left in repayment, could find themselves facing an unexpected tax bill much sooner than they anticipated. For example, a borrower on a 25-year term who goes from having five years of progress towards IDR loan forgiveness to 21 years of progress towards loan forgivness under the IDR Adjustment may get their loans forgiven in only four years, instead of another 20 years. But that loan forgiveness would fall outside of the tax exemption window under the American Rescue Plan Act — potentially subjecting them to significant tax liability in 2026.

Student loan forgiveness of $100,000 could result in a $25,000 to $30,000 tax bill, depending on the borrower’s federal tax bracket and other potential tax exemptions or deductions.

Biden Pushes Congress To Make Student Loan Forgiveness Tax Exemption Permanent

There are some exemptions under the existing tax code that may allow some borrowers facing sooner-than-expected student loan forgiveness under IDR to avoid taxation. For example, a borrower who is insolvent at the time that a debt is cancelled (meaning the value of their debts exceeds the value of their assets) may be able to reduce or even eliminate the resulting tax bill. But this would depend on the borrower’s specific financial circumstances.

In March, President Biden included a provision in his budget proposal that would make federal student loan forgiveness under IDR permanently exempt from taxation. But it ultimately would be up to Congress to pass this, and it is far too early to know whether Congress would include a permanent fix to the student loan forgiveness taxation issue in final budget legislation.

Further Student Loan Reading

If Biden Enacts Broad Student Loan Forgiveness, It May Look Like This

Student Loan Payment Pause: Biden Official Says Repayment Will Resume ‘At Some Point’ — Here’s What That Might Mean

Want Student Loan Forgiveness? To Qualify, Borrowers May Need To Do This First

Who Qualifies For Student Loan Forgiveness Under Biden’s Huge New Expansion Of Income Based Repayment

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