Student loan forgiveness can eliminate your loan balance, but it can also trigger a tax bill, known as a “tax bomb,” because some forgiven debt is taxable. Learn how to prepare for a student loan forgiveness tax bomb.
What is a student loan forgiveness tax bomb?
A student loan forgiveness tax bomb happens when your loan balance is forgiven and you're obligated to pay taxes on the forgiven amount. This can affect borrowers on income-driven repayment plans who've made reduced student loan payments for years.
When should you plan for a student loan tax bomb?
Any amount of federal loans forgiven through income-driven repayment or other means is not considered taxable income through the end of 2025.
If you receive forgiveness after 2025, you may face a large tax bill that’s due in full immediately. The best way to prepare for this is to estimate your projected student loan forgiveness and set aside money before the tax bomb hits.
Who faces a student loan tax bomb?
After 2025, borrowers on income-driven repayment plans may experience a student loan forgiveness tax bomb. IDR plans last up to 25 years, and if you don’t pay off your loan during that term, the remaining balance is forgiven — but taxed as income. Some states also tax student loan forgiveness (see below).
If you receive forgiveness under a different federal student loan program, it will likely be tax-exempt. You won’t face a tax bomb in the following situations:
- You work for a qualifying employer. Amounts forgiven through Public Service Loan Forgiveness and Teacher Loan Forgiveness, as well as the National Health Service Corps Loan Repayment Program and similar repayment programs, aren’t taxable.
- You die or become totally and permanently disabled. This applies to you or the student benefitting from the loan, in the case of parent PLUS loans. In instances of a death discharge, your estate won't be taxed.
- You qualify for a different federal student loan discharge. Loans can be discharged tax-free in instances in which your school defrauded you or closed while you were enrolled, for example.
- Your Perkins loans are canceled. If you taught or performed other employment or volunteer service that qualified for Perkins loan forgiveness, you won’t be taxed on this amount.
If you have a forgiven student loan, you should receive a cancellation of debt form, known as Form 1099-C, for your taxes.
How much will you pay?
The size of a student loan tax bomb depends on the amount forgiven as well as your finances overall. In some instances, the forgiven student loan could push you into a higher tax bracket — further increasing your tax burden.
For example, say you’re married, file taxes jointly and have two dependents. If your taxable income was $100,000 and you claimed the standard deduction, you would fall in the 12% tax bracket and owe about $4,000 in taxes.
But let’s say you also had $50,000 in student loans forgiven. That additional "income" would move your federal return into the 22% tax bracket, increasing your tax bill to around $13,000 — a $9,000 difference.
Some states tax student loan forgiveness
While the federal government explicitly stated in the 2021 American Rescue Plan Act that it wouldn’t collect taxes on student debt forgiven through Dec. 31, 2025, not all states held to the same pledge.
Borrowers in Indiana, Mississippi, North Carolina and Wisconsin must pay state income taxes on some forgiven federal student loans, according to analysis from the Tax Foundation, a tax policy think tank based in Washington, D.C.
Indiana
Indiana residents will be taxed on some forgiven student loan debts, according to the Indiana Department of Revenue’s website.
The state's income tax rate is 3.05%, so individuals could pay up to $305 in taxes for $10,000 in student loan forgiveness. Indiana residents will also have to pay additional county taxes on the forgiven debts.
Mississippi
Mississippi taxes cancelled debt as income, according to the Mississippi Department of Revenue. The state charges a 4.7% income tax on all annual income over $10,000.
North Carolina
Forgiven student loan debts taxed as income in North Carolina, per North Carolina's Department of Revenue. The exception being PSLF borrowers who may be exempt from paying federal or state taxes, according to North Carolina Center for Nonprofits.
The state's individual income tax is currently 4.50%, but that figure changes to 4.25% in 2025 and gradually decreases until 2026, when the rate will stand at 3.99%, per the state's Department of Revenue.
Wisconsin
Forgiven student loan debts through income-driven repayment plans are taxed as income in Wisconsin. Exclusions from state tax include loan forgiveness through PSLF, death or total and permanent disability, teacher loan forgiveness program and National Health Service Corps Loan Repayment plan.
Wisconsin's income tax rate ranges from 3.50% to 7.65%, depending on annual income and whether you're married or single, according to the state's Department of Revenue.
How to prepare for a forgiveness tax bomb
If you don’t think you’ll fully repay your loan over a 10-, 20- or 25-year term, use that time to prepare for the fallout of a potential tax bomb.
- Estimate your bill. Use the Loan Simulator at StudentAid.gov to estimate your loan forgiveness amount and timeline. Tax brackets can change over time, but looking at your earning potential with data from the Bureau of Labor Statistics can help you at least estimate how much you’ll eventually owe.
- Choose the right plan. When deciding between income-driven plans, many factors matter, like your degree and marital status.
- Prioritize saving. Instead of paying extra toward your loan, invest money with your forgiveness tax bomb in mind. For example, set aside $50 a month for your eventual bill. That small amount may not make a dent in your loans, but after 25 years with just 2% compound interest, you’ll have saved more than $19,600 — hopefully enough for your tax bill. A savings goal calculator can help you determine how much to put aside.
What if you can’t afford your tax bill?
Payment plans are available if you can’t afford your tax bill. IRS payment plans charge fees and interest, and rates can change every three months.
In some cases, if the IRS regards you as insolvent — or having liabilities that exceed your assets — you may be able to exclude some or all of the forgiven amount from your income. Talk to a tax professional after your loan is forgiven to understand whether this is an option for you.
