Canceled income-driven student loans could trigger large tax bills

Student loan borrowers whose debt is forgiven through income-driven repayment plans are likely to face much larger federal tax bills when that relief is counted as taxable income again.

Dive Brief:

• According to an analysis by Protect Borrowers, a legal and advocacy nonprofit, borrowers whose debts are canceled through income-driven repayment plans in 2026 could see their next federal tax bill rise by about $6,000 to $12,000.
• The group said that increase could double or triple IDR borrowers’ 2026 tax bill when they file in April. For instance, a married borrower with two dependents would owe an average of $7,206 in extra taxes on canceled IDR debt, pushing their total well above previous expectations.
• The size of the tax hit will vary based on income, tax status and family size. The nonprofit said lower- and middle-income borrowers are likely to face the steepest increases, and most IDR borrowers make under $60,000 a year.

Dive Insight:

Under the American Rescue Plan Act, which took effect during the pandemic, discharged student loan debt was excluded from federal taxable income from Dec. 31, 2020, through Dec. 31, 2025. But after Congress let that protection expire, IDR debt forgiven in 2026 and later years will show up on borrowers’ tax returns.

Protect Borrowers urged federal lawmakers to act in the next budget reconciliation process and make canceled IDR loans permanently tax-free, along with loans discharged through the Repayment Assistance Plan.

The nonprofit said the average discharged IDR loan is worth about $50,000, often more than the original amount borrowed because low monthly payments based on income have not kept pace with accumulating interest.

Single borrowers without children who have discharged IDR loans would owe more than $10,000 in federal taxes if they earned $40,000 in 2026, and nearly $20,000 if they earned $80,000.

After payroll and state taxes, the report said these borrowers could see their take-home income fall by nearly half.

Families with children and lower household incomes could be hit hardest as a share of annual earnings. For a household of four earning $40,000 a year, the analysis found an added tax burden of $10,558 above the expected base bill, including $1,704 in new taxes and $8,854 in lost tax credits.

“Treating such cancelled debt as taxable income will hit many borrowers with an unprecedented tax bomb and force them to replace their debt to the U.S. Department of Education with debt to the Internal Revenue Service,” the analysis said.

The change is also expected to weigh more heavily on borrowers in the South, where loan balances tend to be larger and incomes lower than the national average.

Protect Borrowers said the projected tax jump would leave most borrowers in an impossible financial position after they have already faced major hardship for much of their adult lives.

As of 2022, half of borrowers whose IDR debt was canceled had no bank account or nonretirement savings, the nonprofit said, citing Consumer Financial Protection Bureau survey data.

In addition to Protect Borrowers, a coalition of Democratic senators also urged the Trump administration last November to exempt canceled IDR loans from federal income taxes.

After the recent midterm elections, Democrats are positioned to control both chambers of Congress, which could improve the odds of such a change. President Donald Trump would still retain veto power.