Over the past year, many borrowers have seen loan balances disappear due to forgiveness. In some cases, borrowers even received large refunds.
In the coming months, millions more will benefit from student loan forgiveness programs.
Among all of the good news, there is a growing concern about tax bills. Does student loan forgiveness get taxed? Are refunds from lenders taxable?
Spoiler Alert: In most cases, both the forgiveness and the refunds are tax-free.
Student Loan Refunds: Highly Unlikely to Get Taxed
To understand this concept, let’s be crystal clear about what it means to get a refund: A refund is an overpayment of a bill or debt.
For example, suppose you accidentally paid your credit card company $500 when your bill was only $50. When you get that $450 put back in your checking account, there isn’t any tax liability. A refund on an overpayment of a student loan is the same thing.
Sherpa Clarification: The title of this section says that refunds are “highly unlikely to get taxed” instead of plainly saying they don’t get taxed. My phrasing here is partly a lawyer thing: by qualifying my language, I won’t be wrong if someone gets taxed on a refund.
However, the primary reason for using terms like probably and usually is that there isn’t a uniform set of tax laws. There are federal taxes, state taxes, and local taxes. Within each jurisdiction, there can be some crazy rules.
Where I can, I’ll point out where some states might behave differently than the majority. However, analyzing every state and locality isn’t practical or useful.
PSLF Forgiveness: Not Taxed at Federal Level, States Vary
First, the good news on Public Service Loan Forgiveness: by statute, the federal government does not tax PSLF forgiveness.
States are a different story.
However, the news on this front is still mostly good. Some states don’t have an income tax. In these states, there isn’t a tax bill from PSLF. Likewise, many states follow the federal government in defining income. In these states, PSLF isn’t taxed.
Sadly, in a handful of states, taxes may become an issue.
An interesting component in this analysis is that state laws are rapidly changing. Some states are passing emergency legislation to remove a tax liability on loan forgiveness, while others are passing legislation to tax forgiveness. The best way to find out up-to-date tax rules in your state is to simply Google “PSLF Tax [your state].”
Biden Forgiveness: Not Taxed at Federal Level, Some States Tax
The Biden adminstration previously tried to cancel $10,000 per student loan borrower, the will be adjusting IDR payment counts to forgive debt for many more borrowers, and they are attempting another round of forgiveness for some borrowers.
These forms of forgiveness are all different, but they all are called Biden forgiveness by some borrowers and the tax rules for each type are identical.
Through 2025, there isn’t a federal tax on student loan forgiveness. However, as things stand now, the tax bomb is set to return in 2026. This will require some planning for borrowers on IDR plans, but those who get forgiveness before 2026 won’t have to worry.
At the state level, it’s possible that a state that doesn’t tax PSLF might still tax the one-time forgiveness. As things stand right now, that is the rule in Indiana, and it appears unlikely to change.
If you live in North Carolina, Indiana, Mississippi, Arkansas, or Wisconsin, you may have to pay a tax on one-time forgiveness. However, your state may change its rules moving forward.
What about payments made for others or by others?
Another tax concern for student loan borrowers comes in the form of student loan repayment help.
Suppose a family member is generous enough to pay off some or all of your student debt. Does that help get taxed?
The good news for borrowers is that this help falls into the category of gift taxes. For the recipient of the gift, there isn’t a tax bill. However, the gift-giver may have to pay a gift tax.
Well, I am my own tax preparer and have been all my life, as well as doing tax filings for my own business and for an employer’s business I managed. The “recounting”adjustments that applied to me as well as to anyone whose original loans were sold from one service provider to another (resetting the years that “counted” toward 25 year forgiveness) were very common. Because of those sales and reser of “counts” of years I lost 13 years if credit toward the 25 year count before I consolidated my loans under a direct loan. As a result, I actually made payments for 31 years before the current administration’s recognition of the impact those practices by services had on so many of us.
There are a couple of things to clarify here.
First, when a loan goes from one servicer to another it is not being sold. This is the case with private loans, but when a federal direct loan changes servicers, the Department of Education is simply using a different company to collect payments and service your loans. This should not reset your payment history or progress toward forgiveness.
At the point you consolidated your FFEL loan into a direct loan, you took the steps necessary to get credit for that payment history, but there are no refunds issued for FFEL loan payments because the payment went to a third party, which means there should not be any tax implications.
Going back to your original question, I know you are looking for a definitive answer from me, but it is ultimately a tax question that I’m not comfortable answering because it falls outside the scope of my expertise and I don’t want to give you bad information. If you are doing your own taxes, I’d suggest reaching out to TurboTax or whatever software provider you use. Alternatively, you may wish to reach out directly to the IRS.
What about payments that were made that were all interest, which was deducted from previous years’ taxes, that are part of the refund of overpayment. Wouldn’t that deductible amount then become taxable income? For example, 4 years’ worth of interest only over-payments on an IDR that was deductible student loan interest for each of those 4 years.
Richard, this is a really tricky question. I reached out to a couple of tax experts and didn’t really get conclusive guidance on it, but I do have a few thoughts to share.
First, the situation you describe is pretty rare. If there are over-payments it typically amounts to no more than a few months and should be resolved before you file taxes the following year.
Additionally, the tax documents you receive might also shed some light on the situation. In this case it would be a 1099-C for the debt cancellation or a revised 1098-E from the prior years.
Ultimately, this is a question best directed to your tax preparer.