How refunds and discharges differ — plain-language overview
When a student loan is discharged (for example, through forgiveness, bankruptcy, death, or total and permanent disability), two different money flows can occur:
- A refund: your loan servicer returns money you previously paid (overpayments or amounts collected after the account should have been closed). A refund is generally treated as a return of principal, not taxable income.
- Cancellation of debt (COD): the lender cancels all or part of the outstanding balance. Historically COD is reported to the borrower and the IRS on Form 1099‑C and treated as taxable income unless an exclusion applies.
The key is identifying whether the money you receive is a refund (return of your payments) or income from canceled debt.
Sources and authoritative context: the Internal Revenue Service explains how canceled debt can create taxable income (IRS guidance), the U.S. Department of Education explains federal discharge programs and refunds, and the Consumer Financial Protection Bureau covers servicer practices around refunds and account handling (IRS; U.S. Department of Education; CFPB).
What changed at the federal level through 2025
The American Rescue Plan Act of 2021 temporarily excluded student loan cancellation from gross income for federal income tax purposes for tax years beginning in 2021 through 2025. That means most federal student loan forgiveness or cancellation during this window is not taxable at the federal level. Practically:
- If you receive a 1099‑C for a loan discharged between 2021 and 2025, you may still not owe federal tax on the forgiven amount because of the federal exclusion. Keep the 1099‑C and follow IRS guidance when filing. (IRS; U.S. Department of Education)
- State tax treatment varies. Some states don’t conform to the federal exclusion, so a forgiven amount could still be taxable at the state level.
Note: the federal exclusion is a temporary statutory rule; it expires for discharges after Dec. 31, 2025 unless Congress extends it. Check up-to-date IRS guidance each tax year.
When a refund is NOT taxable
Most refunds are returns of money you previously paid and therefore are not taxable. Common non-taxable refund examples:
- You made an extra payment that was later returned after the loan was discharged.
- The servicer collected payments during an administrative delay and returns those funds once the account is closed.
These are treated like getting back your own money. You should keep records (bank statements, servicer letters, account statements) that show the refund is a return of prior payments.
Example: You overpaid $1,200 in 2022 and your servicer refunds $1,200 after a discharge in 2024. That refund is a return of principal and not federal taxable income.
When a refund or discharge may create taxable income
Situations that can create taxable income include:
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Cancellation of indebtedness reported on Form 1099‑C: Lenders typically issue a 1099‑C when they cancel $600 or more of debt. Historically, that amount becomes COD income and must be reported unless an exclusion applies.
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A servicer refunds money but also reports a cancelled principal balance: If you both get a refund and the lender reports canceled debt, the canceled amount (not the returned overpayment) could be COD income.
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State tax liability: Even where the federal exclusion applies (2021–2025), some states treat forgiven debt as taxable. You could have a state tax bill even with no federal tax owed.
Example: Your lender issues a 1099‑C reporting $20,000 forgiven in 2024. Under the federal exclusion, you may not include it in federal income, but if your state does not conform, the state may count the $20,000 as taxable.
Practical steps to take if you receive a refund after discharge
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Save all documentation. Keep your account statements, payment history, servicer communications, and any 1099‑C or other IRS forms. These records are essential in case of IRS or state queries.
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Determine the nature of the payment you received. Ask your servicer in writing whether the refund is:
- An overpayment return (return of your money), or
- Part of a debt cancellation event reported as COD.
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Watch for Form 1099‑C. If you receive a 1099‑C, do not assume you owe tax. Compare the details with the servicer’s explanation and check current IRS guidance about the 2021–2025 exclusion. (IRS)
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Check state tax rules. If your state doesn’t follow the federal exclusion, plan for possible state tax liability. State departments of revenue often publish conformity guidance.
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Talk to a tax professional. If you see a 1099‑C or have an ambiguous refund, consult a CPA or tax attorney. In my practice I’ve seen clients avoid errors by bringing these documents to their tax advisor before filing.
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Consider filing an amended return if you learn a previously reported forgiven amount should have been excluded. Keep your adviser’s notes and servicer statements as proof.
Common scenarios, explained
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Student loan discharged and no refund issued: The discharge may be reported on Form 1099‑C. Check whether the discharge is excluded at the federal level and what to do for state taxes.
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Student loan discharged and you receive a refund of payments: That refunded amount is generally not income — it’s a return of your funds. Confirm with the servicer and document it.
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Loan initially paid by someone else (e.g., parent) and then refunded to the borrower: Tax consequences can be complicated — consult a tax professional. The refund might be treated differently depending on who made the original payment and whose name is on tax records.
Examples from practice
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Client A (overpayment refund): In my advisory work, a client received a $2,500 refund after a TPD discharge. The servicer labeled it an overpayment refund. We documented payment history and treated it as a return of principal — no federal tax due.
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Client B (1099‑C issued): Another client received a 1099‑C for $18,000 after a grant-related discharge in 2023. We verified the American Rescue Plan exclusion applied and confirmed there was no federal tax due, but the couple had to check state guidance because their state sometimes taxes forgiven student debt.
Forms and filing considerations
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Form 1099‑C: Lenders use this to report cancellation of debt. If you get one, keep it and reconcile it with your account records. (IRS)
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Form 982: Historically used to report exclusion of canceled debt from income for specific exclusions (bankruptcy, insolvency, etc.). Whether you need to use Form 982 depends on the nature of the exclusion. Work with a tax pro. (IRS)
Always check the latest IRS instructions when preparing your return because the paperwork and reporting expectations can shift with new guidance.
Recordkeeping checklist
- Loan account statements showing balances before and after discharge
- Payment history (bank records, canceled checks, electronic payment receipts)
- Written communications from the servicer explaining the refund or discharge
- Any IRS forms received (1099‑C) and IRS or state correspondence
- Notes from conversations with servicers and tax advisors
How this affects planning
If you expect a discharge (forgiveness, TPD, or otherwise), include the possible refund or reporting outcomes in your tax planning. In my experience, proactive tax conversations prevent surprises during tax filing season and help clients take action (such as estimating state tax liabilities or withholding adjustments).
Where to get official, up-to-date guidance
- IRS — guidance on cancellation of debt and any temporary exclusions: https://www.irs.gov
- U.S. Department of Education — details on discharge programs, refunds, and servicer responsibilities: https://www.ed.gov
- Consumer Financial Protection Bureau — consumer-facing guidance on refunds and servicer behavior: https://www.consumerfinance.gov
For related reading on finhelp.io:
- Read about broader forgiveness tax issues: “Tax Implications of Student Loan Forgiveness: What to Expect” (internal link)
- If your discharge was for disability, see: “Student Loan Discharge Due to Total and Permanent Disability” (internal link)
- For bankruptcy differences: “Bankruptcy Discharge vs Student Loan Discharge: Key Differences” (internal link)
Professional disclaimer: This article is educational and does not replace personalized tax or legal advice. Tax law and agency guidance can change; consult a qualified tax professional or the IRS for advice specific to your situation.
Author note: With 15 years advising borrowers, I’ve seen the same pattern — confusion about refunds often causes unnecessary tax-time stress. Clear records and early consultation with a tax advisor usually eliminate surprises.
