Getting your student loans forgiven is a big deal. It feels like a weight has finally lifted. But just when you think you’re done with it, something else might show up: a tax bill. Yes, in some situations, you could owe taxes on canceled student debt. That may sound strange—why would you pay taxes on a loan you didn’t have to repay? But the IRS sometimes treats forgiven loans as if you received extra income. So, instead of making loan payments, you could be expected to pay taxes on the forgiven amount.
This doesn’t happen in every case, though. Whether or not you’re taxed depends on how your loan was canceled and what the tax laws say about it. Some types of forgiveness are completely tax-free. Others aren’t. If you’ve had loans forgiven recently—or expect to have them forgiven soon—it’s important to know the difference.
What It Means When Student Loan Debt Is Canceled
When a loan is canceled, it means you’re off the hook. You don’t have to pay it back anymore. That can happen for different reasons. Maybe you’ve been working in public service and qualify for forgiveness. Maybe you finished a repayment plan that promised to cancel the rest of your debt after a certain number of years. Or maybe your school closed while you were still enrolled.
Whatever the reason, the loan is gone—but now the tax system wants to know: does this count as income?
Here’s how the IRS sees it: if you borrowed money and no longer have to pay it back, that’s kind of like someone giving you free money. Normally, when you receive money—whether it’s from work, selling something, or a gift—it might be taxed. So the IRS often counts forgiven debt as “income” unless there’s a rule that says otherwise.
That doesn’t mean all canceled student loans are taxed. In fact, a lot of them are not. But you do need to know what kind of loan you had and how it was forgiven to know for sure.
When Forgiven Student Loans Can Be Taxed
Not every type of student loan cancellation is tax-free. In fact, some types are fully taxable. It usually depends on how and why the loan was forgiven.
Here are a few situations where canceled student loans can lead to a tax bill:
- You had a private loan and made a deal with the lender to settle it for less than you owed.
- You received a loan directly from your school (sometimes called an institutional loan), and it was canceled outside of a federal program.
- You got federal loan forgiveness that doesn’t fall under a tax-free program or happen after the current tax break ends.
Let’s say you owed $15,000 on a private student loan and your lender agreed to settle it for $10,000. That means they canceled $5,000 of your debt. The IRS may treat that $5,000 like extra income, and you’d be expected to report it when you file your taxes.
How much tax you’d owe depends on your income and your tax bracket. It’s not a penalty. It’s just that the government treats that canceled amount the same way it treats money you earn at work.
When Forgiven Loans Are Not Taxed
Thankfully, many types of student loan forgiveness are not taxable, at least under current laws. If your loan was canceled through an official federal program, there’s a good chance you won’t owe taxes on it.
Here are some cases where student loan forgiveness isn’t taxed:
- Public Service Loan Forgiveness (PSLF): If you work for a nonprofit or government agency and make 10 years of qualifying payments, the rest of your loan can be forgiven, and you don’t pay taxes on that forgiven amount.
- Income-Driven Repayment (IDR) plans: These plans base your payment on what you earn. After 20 or 25 years, whatever is left gets forgiven. Under a law that’s in place until the end of 2025, that forgiven amount is tax-free.
- Total and Permanent Disability Discharge: If you’re unable to work because of a disability and your loans are canceled, that amount isn’t taxed either.
- Closed School or Borrower Defense: If your school shut down or you were misled into taking out loans, your loans may be canceled, and you won’t pay taxes on the forgiven amount, at least under current rules.
These tax-free programs are written into law or protected by temporary rules. But it’s still smart to keep records and make sure the forgiveness you received fits into one of these categories.
Why the American Rescue Plan Matters
There’s one law you should know about: the American Rescue Plan Act, passed in 2021. This law says that any student loans forgiven between 2021 and 2025 are not taxed at the federal level, no matter how they were canceled.
This tax break applies to:
- Federal Direct Loans
- FFEL Loans
- Perkins Loans
- Parent PLUS Loans
- Some private loans, but only if they were canceled through a government or state program
This law gives borrowers a window of time—through December 31, 2025—to have loans forgiven without worrying about a tax bill from the IRS. But unless new laws are passed, that window will close. After that, loan forgiveness might be taxable again. So if you expect to have your loans forgiven in 2026 or later, be ready for that possibility.
How Canceled Loans Show Up on Your Tax Return
If your loan is canceled and it’s considered taxable, you’ll probably get a Form 1099-C in the mail. This form tells you (and the IRS) how much debt was forgiven. The lender is required to send this form if the canceled amount is $600 or more.
That amount goes on your tax return as “other income.” It’s added to your total earnings for the year and could increase how much you owe.
But if your loan was canceled under a tax-exempt program—like PSLF or the American Rescue Plan—you’ll need to fill out another form: IRS Form 982. This form tells the IRS that you’re allowed to exclude the canceled debt from your income.
Filing these forms correctly is important. If you don’t, the IRS might think you owe more than you do. Or worse, they might send you a notice or a penalty.
What to Do If You Receive a 1099-C
Getting a 1099-C in the mail can be confusing, especially if you thought your loan forgiveness was tax-free. Don’t panic. Start by checking the form carefully. Make sure the loan, the amount, and the date are correct.
Next, ask yourself: Does this forgiveness qualify for a tax exclusion? If it does, make sure to:
- Attach Form 982 to your tax return
- Keep copies of your loan discharge paperwork
- Double-check that you’re not accidentally reporting the forgiven amount as income
If it doesn’t qualify for an exclusion, you’ll need to include the amount on your return and pay tax on it. Either way, don’t ignore the form. It means the IRS already knows your debt was canceled, and they’ll expect you to address it on your return.
How to Prove Your Forgiveness Shouldn’t Be Taxed
If you’re claiming that your forgiven student loans shouldn’t be taxed, you’ll want to keep clear records. If the IRS asks for proof, you need to be ready to show them how your forgiveness fits under a tax-exempt program.
Here’s what you should keep:
- The letter or email confirming your loan was canceled
- Any documents explaining why the loan was forgiven (e.g., disability discharge, public service approval)
- A copy of Form 982 from your tax return
- A copy of the 1099-C, if you received one
It’s not about being paranoid—it’s about being prepared. If everything is in order, you won’t have anything to worry about.
What About State Taxes?
Even if your loan forgiveness is tax-free at the federal level, your state might still tax it. Not all states follow federal tax laws. Some make their own decisions about what counts as income.
Right now, states like Indiana, Mississippi, and North Carolina don’t follow the federal rule that makes student loan forgiveness tax-free through 2025. So if you live in one of these states, you might owe state income tax even if you don’t owe anything to the IRS.
That’s why it’s a good idea to check your state’s rules or talk to a local tax preparer. Just because you’re safe from federal taxes doesn’t always mean you’re safe from state taxes.
How a Taxable Loan Forgiveness Can Affect You
If your forgiven loan is taxable, it can have a big effect on your finances. Adding $10,000, $20,000, or even $50,000 to your income in one year could move you into a higher tax bracket. That means you’ll owe more than usual, and you might lose access to certain tax credits or benefits.
For example, if you normally qualify for the Earned Income Tax Credit or health insurance subsidies, you could lose them for the year that the debt is forgiven. You could also end up owing a bigger refund or even getting hit with an unexpected tax bill.
That’s why it helps to plan. If you know your loan will be forgiven soon—and you’re not sure whether it’s taxable—talk to a tax advisor. It’s better to be ready than caught off guard.
Common Misunderstandings That Trip People Up
Many people assume loan forgiveness is always tax-free. That’s just not true. Here are a few myths that confuse:
- “If I didn’t get a 1099-C, I don’t have to do anything.” You might still have to report the canceled debt, depending on the program.
- “Private loan forgiveness is tax-free, too.” Usually, it’s not. Unless it’s part of a special state or legal settlement, forgiven private loans are often fully taxable.
- “Loan forgiveness from any source is safe under the American Rescue Plan.” Only certain types of loans and programs are covered. Not everything qualifies.
The rules are tricky, but understanding them can save you a lot of money and stress later.
What Could Change After 2025
Right now, we’re in a good place. Thanks to the American Rescue Plan, most federal student loan forgiveness is tax-free until December 31, 2025. But unless Congress extends that rule, things will go back to how they were before, where some forgiveness is taxed and some isn’t.
That means if your loan won’t be forgiven until 2026 or later, you might face taxes unless lawmakers step in again. It’s worth watching what happens in Congress over the next year or two. A simple change in policy could affect whether your forgiven debt ends up on your tax return.
How to Get Ready Just in Case
If you think your loan might be forgiven soon—or even a few years from now—it makes sense to prepare. That way, if the forgiveness is taxable, you won’t be shocked.
Here’s what you can do:
- Estimate how much might be forgiven
- Find out whether it’s likely to be taxable
- Set aside a little money in a separate savings account
- Adjust your tax withholding if needed
- Keep all your loan records in one place
Planning doesn’t mean you expect bad news—it just means you’re ready either way.
Where to Go for Help
This stuff can be confusing, and you don’t have to figure it all out alone. If you’re not sure what to do, talk to someone who deals with this every day.
Good places to get help:
- A certified tax preparer or accountant
- A nonprofit credit counseling agency
- IRS helpline: 1-800-829-1040
- Your loan servicer or the Federal Student Aid website
- A local legal aid office or free tax clinic
When in doubt, ask. A 10-minute phone call could save you hours of paperwork or hundreds of dollars in taxes.
Final Thought
Loan forgiveness should feel like a relief, not a headache. And it can be, as long as you understand the tax rules that come with it. Some forgiven loans are tax-free, others are not. Knowing the difference and being ready with the right forms and records helps you stay in control. You worked hard to earn that forgiveness. Don’t let taxes turn it into a surprise you weren’t ready for.