If you’re counting on student loan forgiveness and breathing easy thanks to the current tax exemption, it’s time for a wake-up call. Republican lawmakers are working to bring the tax-free forgiveness era to an end by setting a date to cancel the tax relief, and the clock is ticking.
What is a student loan forgiveness tax bomb?
Let’s talk about something not many borrowers think about: the tax bomb. That’s what happens when your forgiven student loan balance suddenly becomes taxable income. If you’ve been on an income-driven repayment (IDR) plan for years and your remaining balance is wiped away — great, right? Not so fast. That forgiven amount could now count as income, and the IRS will expect its cut.
Why 2025 is the critical year
Thanks to the American Rescue Plan, any student loan debt forgiven through 2025 is not subject to federal taxes. That was a huge win for borrowers. But if Congress doesn’t extend the tax relief, anyone receiving forgiveness after December 31, 2025, could be looking at a hefty tax bill.
Republican lawmakers in the House have signaled they plan to set that end date in stone, effectively making 2025 your deadline to get tax-free forgiveness. If you’re on a 20- or 25-year repayment plan, that could mean preparing now for a big tax surprise later.
Who’s at risk?
Most at risk are borrowers on income-driven plans. If your loans are forgiven after decades of payments, that forgiven amount could be taxed as income. Imagine owing $50,000 less in student loans — and suddenly $50,000 more in taxable income.
Some types of forgiveness are still safe:
- Public Service Loan Forgiveness (PSLF)
- Teacher Loan Forgiveness
- Discharges due to death or permanent disability
- Forgiveness due to school closure or fraud
But if your forgiveness comes from an IDR plan after 2025, the IRS could come knocking.
Some states will still tax you
Even if Congress extends federal relief, some states already tax forgiven debt, and they’re not budging. If you live in Indiana, Mississippi, North Carolina, or Wisconsin, forgiven loans could boost your state tax bill by hundreds or even thousands of dollars.
How to prepare now
So, what can you do? Start planning.
- Estimate your future tax bill. Use the Loan Simulator on StudentAid.gov to see what you might owe.
- Start saving. Even setting aside $50 a month can add up over time. With modest interest, you could build a savings cushion large enough to cover your tax bill.
- Talk to a tax professional. If you’re insolvent — meaning your debts are greater than your assets — you might not owe tax on your forgiven debt at all. But you’ll need expert advice to make that call.
What if you can’t pay?
You’re not alone. If a tax bomb hits and you can’t afford the bill, the IRS offers payment plans. They come with fees and interest, but at least they can keep you out of bigger trouble.
Read now: How much will you pay each month for a $300,000 mortgage?
