Tax Implications of Forgiven Student Loans After Discharge

Overview

When a lender or the Department of Education cancels or forgives your student loan balance, the discharged amount historically counted as taxable income under IRS rules for canceled debt (see IRS Topic No. 431). However, a temporary federal rule in the American Rescue Plan (effective for discharges from 2021 through 2025) excludes most federal student loan forgiveness from gross income for federal tax purposes. That change dramatically reduces the federal tax exposure for many borrowers but does not necessarily resolve state tax treatment or issues with paperwork such as Form 1099‑C.

This article explains how to determine whether forgiven student loans are taxable, what paperwork to expect, how to handle state taxes, and practical planning steps. It also includes real-world examples and common mistakes to avoid. For background on types of forgiveness and discharge, see our explainer on student loans and the difference between forgiveness and discharge.

Internal links

• Learn more about general student loan types: Student Loans (https://finhelp.io/glossary/student-loans/).
• For differences between forgiveness and discharge, see Student Loan Forgiveness vs. Discharge (https://finhelp.io/glossary/student-loan-forgiveness-vs-discharge/).

What changed at the federal level (2021–2025)

The American Rescue Plan Act of 2021 included a provision that excludes discharged federal student loan debt from gross income for tax years 2021 through 2025. In practice, this means most federal loan forgiveness—whether through Public Service Loan Forgiveness (PSLF), Income‑Driven Repayment (IDR) forgiveness, or other federal discharge programs—will not be treated as taxable income at the federal level if the discharge occurs within that window (see U.S. Department of Education guidelines and IRS guidance).

Key points:

• The exclusion applies to qualifying federal student loan discharges that occur between 2021 and December 31, 2025 (American Rescue Plan Act). (Department of Education: https://studentaid.gov/man-age-loans/forgiveness-cancellation and IRS Topic No. 431: https://www.irs.gov/taxtopics/tc431).
• If the exclusion applies, borrowers do not include the discharged amount as taxable income on their federal return for that tax year.
• The exclusion is temporary. If Congress does not extend it, discharges occurring after 2025 may again be taxable under standard canceled‑debt rules.

Which discharges are generally excluded vs. potentially taxable

• Excluded (federal level, 2021–2025): Most federal program discharges (PSLF, Teacher Cancellation, IDR forgiveness for federal loans, certain borrower defense discharges) that meet program rules and have a discharge date in the 2021–2025 window.
• Potentially taxable: Private student loans discharged by a private lender, negotiated settlements with private creditors, and some non‑federal discharges. Private lenders routinely report cancellation of indebtedness on Form 1099‑C, which generally creates taxable income absent an exclusion or insolvency/bankruptcy exception (IRS Topic No. 431).

Always confirm whether a particular discharge is covered by the federal exclusion—and whether that exclusion affects your state return (see next section).

Forms, notices, and paperwork you should expect

• Form 1099‑C, Cancellation of Debt: Lenders or servicers typically issue this form when they cancel $600 or more of indebtedness. Receiving a 1099‑C does not automatically mean the amount is taxable; it is an informational form the IRS also receives. If you receive a 1099‑C for a federal loan discharge covered by the 2021–2025 exclusion, keep it with your records and maintain documentation showing the discharge and the federal program. (IRS Topic No. 431: https://www.irs.gov/taxtopics/tc431)
• Servicer or Department of Education discharge letters: Save official notices that describe the reason for discharge and the date. That discharge date often determines the tax year and whether the ARP exclusion applies.

If you receive a 1099‑C for a discharge you believe is excluded, contact the loan servicer and request clarification or a corrected form. Keep copies of any correspondence.

State tax treatment: important variation

States do not all follow federal tax law. As of 2025:

• Many states conform to the federal exclusion and treat forgiven federal student loans excluded from federal taxable income as non‑taxable at the state level.
• Several states either do not conform automatically or have rules that treat canceled debt differently; some states may tax forgiven student loans even if the IRS excludes them.

Action steps:

• Check your state tax agency’s guidance or consult a state tax professional before assuming a federal exclusion eliminates state tax liability.
• If your state treats the discharge as taxable, consider whether state tax relief, credits, or installment plans are available.

How to determine whether you owe tax on forgiven student loans

1. Confirm the type of loan (federal vs. private) and the program that generated the forgiveness (PSLF, IDR, borrower defense, settlement, etc.).
2. Verify the discharge date. If the discharge date falls between 2021 and 2025 and the loan is a qualifying federal loan forgiven under a covered program, federal exclusion likely applies.
3. Watch for a Form 1099‑C and keep official discharge notices from your servicer or the Department of Education.
4. Check state rules for tax treatment of discharged debt and estimate any state tax exposure.
5. If you receive a 1099‑C but believe you have an exclusion, keep documentation and consult a tax professional to correct your federal return if needed.

Practical examples (realistic numbers)

Example A — PSLF (federal loans, discharge in 2024): A public school teacher receives $50,000 of federal loan forgiveness through PSLF discharged in August 2024. Under the ARP exclusion, that $50,000 is excluded from federal gross income for tax year 2024, so there is no additional federal tax. The teacher should keep the PSLF award letter and discharge documentation in case a servicer erroneously issues a 1099‑C.

Example B — IDR forgiveness (federal loans, discharge in 2026): A social worker completes 20 years of qualifying payments under IDR and receives $100,000 of forgiveness with a discharge date in 2026. Because the ARP exclusion currently applies only through 2025, this discharge could be taxable at the federal level unless Congress extends the exclusion or another law applies.

Example C — Private loan settlement: A borrower settles a private student loan for $20,000 and the lender issues a 1099‑C showing $20,000 canceled. Unless another exception applies (such as insolvency or bankruptcy discharge), that amount is likely taxable income in the year of cancellation.

Recordkeeping and tax‑planning steps I recommend (from practice)

• Keep all discharge letters, servicer statements, and award notices permanently. I have seen cases where borrowers received 1099‑C forms in error; the paperwork makes it far easier to correct returns.
• If the discharge is federal and within the 2021–2025 exclusion window, maintain documentation showing program eligibility (e.g., PSLF employment certification, IDR payment history). This helps if your servicer or the IRS questions the tax treatment.
• If you receive a 1099‑C for a discharge you believe is excluded, do not ignore it. Contact the issuer and ask for a corrected form; also contact a tax professional if needed.
• Plan for the possibility that Congress might not extend the exclusion beyond 2025. If you expect large IDR forgiveness after 2025, set aside some funds or explore timing strategies with your tax advisor.

Common mistakes and misconceptions

• Assuming all forgiven loans are tax‑free: Not all discharges are excluded—private loan cancellations and discharges after 2025 may be taxable.
• Ignoring Form 1099‑C: Even if excluded federally, failing to respond to a 1099‑C or to keep documentation can create unnecessary complications.
• Not checking state rules: State tax exposure can change the practical tax outcome.

What to do if you received a 1099‑C in error

• Contact the lender or servicer immediately and request a corrected 1099‑C.
• Keep the original 1099‑C and any correspondence as proof that you disputed or clarified the issue.
• If needed, file your federal return excluding the discharge (if the exclusion applies) and attach a statement explaining the basis for exclusion and copies of the discharge notice. Consult a tax professional for the correct procedure for your situation.

When to get professional help

• You received a 1099‑C and aren’t sure whether the debt is excluded.
• You have a large discharge projected after 2025 and want to model potential tax liability.
• Your state has different rules or your situation involves insolvency, bankruptcy, or complex settlement terms.

Final takeaway

Federal rules currently exclude most federal student loan discharges that occur between 2021 and 2025 from gross income, which reduces federal tax liability for many borrowers who receive forgiveness during that period. Private loan cancellations and discharges outside that window may still be taxable. Keep careful records, watch for Form 1099‑C, confirm your state tax treatment, and consult a tax professional to avoid surprises.

Professional disclaimer
This content is educational and does not constitute tax, legal, or financial advice. Use this information as a starting point and consult a qualified tax advisor or CPA about your specific circumstances.

Authoritative sources

• IRS, Topic No. 431, Canceled Debt: https://www.irs.gov/taxtopics/tc431
• U.S. Department of Education, Loan Forgiveness & Cancellation: https://studentaid.gov/manage-loans/forgiveness-cancellation
• Consumer Financial Protection Bureau, Student Loan Forgiveness or Cancellation: https://www.consumerfinance.gov/ask-cfpb/what-is-student-loan-forgiveness-or-cancellation-en-1891/