Some student loan borrowers who have their remaining balances forgiven this year could face thousands of dollars in additional federal taxes. And certain borrowers will be paying nearly $12,000 more, according to a new report from Protect Borrowers. The nonprofit estimates that borrowers receiving forgiveness through income-driven repayment, or IDR, could incur roughly $6,000 to nearly $12,000 in additional federal taxes and lost tax credits, depending on their income and family size.
A temporary federal exemption that prevented many forms of canceled student loan debt from being treated as taxable income applied to discharges after December 31, 2020, and before January 1, 2026. However, it was not extended for IDR forgiveness beyond 2025. Depending on the plan, borrowers may have their remaining balance forgiven after making qualifying payments for 20 or 25 years.
The problem for borrowers now reaching the end of that journey is that a $50,000 student loan balance disappearing does not necessarily mean the federal government treats the transaction as having no financial value. Generally, the IRS considers canceled or forgiven debt taxable unless an exclusion or exception applies. And if the canceled debt is taxable, it generally must be reported as income for the year in which the cancellation occurred.
For five years, student loan borrowers benefited from this unusually broad exception, but now the financial consequences may be coming back to haunt them. Protect Borrowers estimates 2 million to 3 million borrowers could become eligible for IDR cancellation and potentially be exposed to the resulting federal "tax bomb" over the coming decade. Nearly 13 million Americans are currently enrolled in IDR plans and accumulating progress toward possible cancellation, according to the report.
Not every borrower receiving student loan forgiveness will suddenly owe $12,000 to the government. Protect Borrowers modeled different scenarios using a national average canceled IDR balance of $49,697 and borrowers earning $40,000, $60,000 or $80,000. It then calculated the effects for single borrowers without children, single parents with two dependents and married couples with two dependents.
However, for a single borrower earning $60,000, the report estimates a federal tax bill of $15,303 after the modeled loan cancellation, compared with $4,720 if the canceled debt were not taxed. That amounts to an additional $10,583 in taxes. Meanwhile, at $80,000 of income, the report estimates additional costs ranging from $5,964 for a married borrower with two dependents to $11,641 for a single borrower without dependents.
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