The Looming Student Loan Tax Burden: What Borrowers Need to Know
For millions of Americans, the promise of student loan forgiveness is becoming increasingly complex – and potentially more expensive. A recent shift in federal tax policy, coupled with ongoing legal challenges to key forgiveness programs, is creating a landscape where previously tax-free debt cancellation could trigger significant tax bills. This isn’t a future problem; it’s unfolding now, with implications for both federal and state taxes, particularly in states like Illinois.
The End of the American Rescue Plan’s Tax Break
Until recently, the American Rescue Plan Act offered a temporary reprieve, excluding student loan debt from federal income taxes. That provision expired at the end of 2023. Now, canceled or partially forgiven student loan debt is once again considered taxable income. This means borrowers could owe hundreds, even thousands, of dollars in taxes on amounts they thought were being wiped clean. The Protect Borrowers report highlights that two-thirds of those receiving loan cancellation under income-driven repayment plans earn less than $50,000 annually – a demographic particularly vulnerable to this “tax bomb.”
Trump’s “One Big Beautiful Bill” and Its Lasting Impact
The situation is further complicated by the One Big Beautiful Bill Act, enacted last summer. While touted for other provisions, it failed to permanently extend the student loan tax forgiveness exclusion. This means the tax implications will persist for loan cancellations in 2026 and beyond. Experts estimate the tax burden could reach up to $10,000, depending on individual income levels.
SOURCE: U.S. Department of Education. Graphic by Sam Freeman, Medill Illinois News Bureau
State-Level Taxes Add to the Burden
The problem doesn’t stop at the federal level. Illinois, along with 19 other states, automatically conforms to federal tax changes. Unless state lawmakers intervene – and a recent bill decoupling state and federal taxes focused on corporate taxes, not student loans – Illinois borrowers will face a state tax bill on their forgiven debt as well. Senator Mike Halpin (D-Rock Island) has expressed support for decoupling, but the issue hasn’t yet gained traction in the state legislature.
The SAVE Plan and Ongoing Legal Battles
Adding to the uncertainty, President Biden’s Saving on Valuable Education (SAVE) plan, designed to lower monthly payments and accelerate forgiveness, has been stalled by legal challenges from Republican-led states. This has left over 7 million borrowers in forbearance, preventing them from making progress toward forgiveness. A proposed settlement with Missouri could end the SAVE plan entirely, forcing borrowers onto other income-driven repayment plans.
What Happens to Other Repayment Plans?
The legal battles aren’t limited to SAVE. The Income-Contingent Repayment (ICR) and Pay As You Earn (PAYE) plans were also suspended due to the same lawsuit. While loan forgiveness under these plans is expected to resume in February, they are slated to be phased out by July 2028 under the “One Big Beautiful Bill.” Borrowers will need to transition to income-based repayment or a new Repayment Assistance Plan (RAP).
RAP, while offering potential benefits like interest subsidies, also extends the repayment term to 30 years – longer than current income-driven repayment options. Furthermore, RAP may result in higher monthly payments for the lowest-income borrowers.
Graphic by Sam Freeman, Medill Illinois News Bureau
Parent PLUS Loans Face Additional Scrutiny
Borrowers with federal Parent PLUS loans, often limited to the ICR plan, could also see changes to their repayment options. This adds another layer of complexity for families already navigating the challenges of student debt.
Did you know? The Federal Student Aid website offers a loan simulator to help borrowers estimate payments and explore repayment plan options.
Future Trends and What to Expect
The future of student loan forgiveness is far from settled. Several key trends are emerging:
- Increased Scrutiny of Forgiveness Programs: Expect continued legal challenges to income-driven repayment plans and other forgiveness initiatives.
- Shift Towards Income-Based Repayment: Income-based repayment is likely to become the dominant repayment option, but with potentially higher long-term costs due to extended repayment terms.
- State-Level Action: More states may consider decoupling from federal tax policies to protect borrowers from unexpected tax burdens.
- Focus on Repayment Assistance: The rollout of the new Repayment Assistance Plan (RAP) will be crucial, but its impact on borrowers remains to be seen.
Resources for Borrowers
Illinois Attorney General Kwame Raoul encourages borrowers with questions to call the Student Loan Helpline at 1-800-455-2456 for free resources and guidance.
FAQ: Student Loan Tax Forgiveness
Q: Will all student loan forgiveness be taxed?
A: Generally, yes. The tax exemption expired at the end of 2023, meaning forgiven debt is now considered taxable income.
Q: What is the “tax bomb”?
A: It refers to the unexpected tax liability borrowers may face on previously tax-free student loan forgiveness.
Q: Can Illinois prevent me from being taxed on forgiven debt?
A: Possibly. State lawmakers could decouple from federal tax policy, but no action has been taken yet.
Q: What is the SAVE plan?
A: The Saving on Valuable Education plan is an income-driven repayment plan that lowers monthly payments and accelerates forgiveness, but it’s currently facing legal challenges.
Q: Where can I find more information?
A: Visit the Federal Student Aid website (https://studentaid.gov/) or contact the Student Loan Helpline (1-800-455-2456).
Pro Tip: Don’t wait until tax season to address this issue. Review your loan forgiveness status and potential tax implications now to avoid surprises.
Have questions about your student loan situation? Share them in the comments below, and we’ll do our best to provide helpful information. Explore our other articles on personal finance and student debt for more insights.
