Tax Implications of Loan Forgiveness: What Borrowers Should Know

How forgiven loans usually affect your taxes

When a lender cancels, forgives, or discharges a debt, the IRS typically treats the forgiven amount as taxable income called Cancellation of Debt (COD) income. Creditors often report canceled debt on Form 1099-C (Cancellation of Debt), which you may receive after forgiveness or settlement. The basic tax flow is:

• Creditor cancels debt → Creditor may send Form 1099-C → Borrower includes amount on tax return unless an exclusion applies.

Authoritative guidance: the IRS explains COD rules and reporting on 1099-C; for student loans the CFPB also provides consumer-oriented guidance on how forgiveness affects taxes (see IRS and CFPB links below).

Sources: IRS (Cancellation of Debt and 1099-C guidance) and CFPB (consumer Q&As on student loan forgiveness).

Key exceptions and exclusions to know (2021–2025 and beyond)

• Student loans (temporary exemption): The American Rescue Plan Act of 2021 made federal and private student loan discharges excludable from gross income for tax years 2021 through 2025. That means many borrowers with loan forgiveness during this window generally do not owe federal income tax on discharged student loan amounts. See IRS guidance for details and any updates before filing. (IRS; see also CFPB summary.)

• Program-based non-taxable forgiveness: Certain programs result in debt discharge that is not treated as taxable income. For example, forgiveness through Public Service Loan Forgiveness (PSLF) or qualifying Income-Driven Repayment (IDR) forgiveness has specific rules and may be excluded under ARPA for 2021–2025. See our PSLF guidance for documentation steps.

• Insolvency: If you were insolvent (liabilities exceed assets) immediately before debt cancellation, you may exclude some or all COD income using Form 982. You must determine insolvency under IRS rules and keep documentation.

• Bankruptcy: Debts discharged in a Title 11 bankruptcy are excluded from taxable income.

• Other statutory exceptions: A few other limited exclusions exist (e.g., certain farm debts, nonrecourse loans in specific contexts). Always check current IRS publications.

Common sources of forgiven debt and how taxation usually differs

• Student loans (federal/private): Generally COD income, but ARPA made many student loan discharges tax-free through 2025. Private loan discharges outside ARPA or other law may still be taxable unless another exception applies. (CFPB; IRS.)

• Mortgages: Forgiven mortgage debt after a short sale or foreclosure can trigger COD income. Some mortgage relief exclusions applied in past tax law (e.g., qualified principal residence indebtedness), but many of those provisions have expired or changed—check the current year guidance. See our pages on mortgage tax consequences and loan modification for borrower options.

• Credit cards, personal loans, medical debt: These are typically taxable COD income unless you qualify for insolvency or bankruptcy exclusions.

• Settlements with creditors: A negotiated settlement (e.g., pay less than owed) creates COD income on the forgiven portion unless excluded.

What forms to expect and how to report

• Form 1099-C: Creditors generally report canceled debt of $600 or more on Form 1099-C. Receiving a 1099-C does not automatically mean you owe tax; it triggers review. Keep the form and verify the amount and date of discharge.

• Form 982: Used to report exclusions from COD income (for insolvency, bankruptcy, or certain statutory exclusions). The instructions explain how to calculate the amount you can exclude and any adjustments to tax attributes.

• Reporting student loan exclusions: Even when ARPA excludes student loan forgiveness from income, save documentation from your loan servicer and follow IRS guidance. The IRS may still require records; rules can change after 2025.

Action step: If you receive a Form 1099-C, do not ignore it—confirm accuracy, calculate any excluded amount, and, when appropriate, file Form 982 or consult a tax professional.

Practical examples and scenarios (real-world framing)

Example 1 — PSLF borrower: Jane works for a nonprofit and qualifies for PSLF. After 120 qualifying payments, the remaining federal loan balance is forgiven. Under current rules and ARPA’s student-loan exclusion (2021–2025), Jane typically does not report that forgiven amount as taxable income on federal returns. Keep PSLF documentation (employment certification forms, payment records) in case of IRS questions.

Example 2 — Credit card settlement: Mark negotiates a settlement with a credit card company and pays $6,000 on a $10,000 balance. The creditor issues a 1099-C for $4,000. Unless Mark can show insolvency or another exclusion applies, that $4,000 is likely taxable COD income and should be reported.

Example 3 — Mortgage short sale: Anna does a short sale and the lender cancels $30,000 of mortgage debt. Depending on whether the mortgage relief exclusion applies for that tax year, Anna may have COD income and must consider reporting and state tax consequences.

State tax differences — what to watch for

States do not always follow federal tax treatment. Some states may tax forgiven debt that is excluded federally (or vice versa). Before assuming tax-free status on your state return, check your state’s revenue department guidance or consult a CPA. See our FinHelp guide on how loan forgiveness affects state taxes for links and state-by-state notes.

Internal resources:

• Learn how loan forgiveness affects state taxes differently than federal rules: How Loan Forgiveness Affects State Taxes Differently Than Federal
• For PSLF documentation and eligibility: PSLF: Public Service Loan Forgiveness – Eligibility Checklist

Practical tax planning steps (checklist)

1. Expect and save Form 1099-C if you receive forgiveness. Compare creditor amounts to your records.
2. Verify whether an exclusion applies (ARPA for student loans 2021–2025, bankruptcy, insolvency). Document proof.
3. If you claim insolvency or another exclusion, prepare Form 982 and supporting calculations.
4. Recalculate estimated tax or adjust withholding if an unexpected COD amount is taxable to avoid underpayment penalties.
5. Consult a tax professional for complex cases (mortgage short sales, multi-year settlements, mixed student/private loans).
6. Check your state tax rules and file any required state forms.

Common mistakes to avoid

• Assuming “forgiven” always means “tax-free.” Many non-student loan discharges remain taxable.
• Tossing mail: Keep 1099-Cs, settlement letters, bankruptcy discharge orders, and loan servicer notices.
• Forgetting state returns: A federal exclusion won’t automatically erase state tax exposure.

In my practice — practical tips I give clients

• Always demand written confirmation of the exact forgiven amount and date from the lender.
• If you expect forgiveness, run a tax projection before year-end so you can increase withholding or make estimated payments if needed.
• Keep a simple folder (digital or paper) with payment histories, settlement letters, 1099-Cs, discharge orders, and employer certification for programs like PSLF.

When to get professional help

• You receive a Form 1099-C and aren’t sure whether you qualify for an exclusion.
• Your forgiven debt spans multiple years or includes mixed loan types (student + private loans + credit card).
• A mortgage short sale, foreclosure, or complicated settlement could create large COD income exposure.

A CPA or tax attorney can review Forms 1099-C, prepare Form 982 where needed, and advise on state filing impacts.

FAQ highlights

• Will I always get a Form 1099-C? Not always. Creditors must file when certain thresholds and rules are met. Even without a 1099-C, you should report taxable COD income.

• Is student loan forgiveness taxed in 2025? Under the American Rescue Plan Act (ARPA), student loan discharges are excluded from gross income for tax years 2021 through 2025. Check current IRS updates for any changes after 2025.

• Can I exclude forgiven debt if I was insolvent? Yes — partially or fully — if liabilities exceeded assets before the discharge. Use Form 982 and keep documentation.

Authoritative resources and next steps

• IRS — Cancellation of Debt, Insolvency, and related guidance (search “IRS cancellation of debt 1099-C” at irs.gov).
• IRS — Student loan tax guidance and ARPA provisions (see IRS announcements and FAQs).
• CFPB — Consumer guidance on student loan forgiveness and taxes: https://www.consumerfinance.gov/

For more FinHelp articles on related topics, see:

• Tax Considerations After Receiving Loan Forgiveness in 2025: https://finhelp.io/glossary/tax-considerations-after-receiving-loan-forgiveness-in-2025/
• Student Loan Discharge: When Debt Can Be Eliminated: https://finhelp.io/glossary/student-loan-discharge-when-debt-can-be-eliminated/

Disclaimer

This article is educational and does not constitute tax or legal advice. Tax law changes and can be complex; consult a qualified tax professional or attorney for guidance tailored to your situation.

Updated: 2025 — based on current IRS guidance and the American Rescue Plan Act of 2021. Always check the latest IRS and state guidance before filing.