Student loan forgiveness is taxable once more: Begin preparing for the ‘tax bomb,’ CFP advises.

Potential Tax Implications for Student Loan Forgiveness Post-2026

Borrowers who have their student loans canceled after 2026 may encounter significant tax liabilities. The tax protection on student loan forgiveness provided by the American Rescue Plan Act of 2021 is set to expire on December 31, 2025. Notably, this provision was not extended or made permanent under complications involving past administrations.

Experts are advising borrowers who have recently received or anticipate receiving loan forgiveness to take action sooner rather than later to get ready for potential tax implications.

The upcoming tax changes primarily affect those using the Department of Education’s Income-Driven Repayment Plans (IDR). These plans, introduced in the 1990s, limit monthly payments to a certain percentage of a borrower’s discretionary income and forgive any remaining debt after a specific duration—typically 20 to 25 years.

“Many borrowers are nearing the 20- or 25-year mark,” observed Ethan Miller, a certified financial planner who specializes in student loans in the Washington area. He emphasized that these individuals should consider the ramifications of what some call a “tax bomb.”

Unlike IDR plans, the Public Service Loan Forgiveness Program offers relief to government and nonprofit employees, allowing for loan forgiveness after 120 qualifying payments—and it remains tax-free.

According to higher education expert Mark Kantrowitz, the average loan balance for borrowers using IDR plans is around $57,000. He estimated that for someone in the 22% tax bracket, this could translate to a tax bill exceeding $12,000, while lower-income earners in the 12% bracket might still face around $7,000 in taxes. Furthermore, borrowers may also be subject to state taxes on their forgiven loans.

Eligibility for Student Loan Forgiveness in 2025

These tax concerns arise even as many borrowers are experiencing delays in getting their loans forgiven. Nevertheless, a recent agreement involving the American Federation of Teachers and the Education Department indicates that borrowers recognized as eligible for forgiveness in 2025 will not have to pay federal taxes, even if the cancellation is confirmed later.

If you’re notified of your eligibility for debt cancellation in 2025, it’s vital to document that confirmation, suggested Nancy Nearman, who assists consumers with education debt in New York. This record can help prove your eligibility for relief before the expiration of the tax exemption.

Preparing for Potential Tax on Student Loan Forgiveness

Starting in 2026, student loan forgiveness will be treated as income, which could significantly impact borrowers’ finances. “Tax increases will vary based on the size of the forgiven debt,” pointed out Landon Wormund, a certified financial planner.

This change could raise tax obligations and have implications for various credits and deductions. Wormund, also a member of CNBC’s Financial Advisor Council, emphasized the importance of being proactive and planning ahead for these potential changes.

One of the first steps is understanding when you qualify for an IDR plan exemption. This task may be tougher now since some tracking tools have been removed, with no current plans to reinstate them per a recent report from the Department of Education. However, working with a financial adviser could help determine when you will qualify and allow you to start estimating any potential tax owed based on your income.