As millions of student loan borrowers try to navigate a repayment system mired in unprecedented turmoil, a new threat looms on the horizon: potential changes to the federal tax treatment of student loan forgiveness and and repayment. Collectively, these reforms may have significant and costly ramifications for many Americans who have student loan debt.
Student loan borrowers are already facing a myriad of problems. The SAVE plan, a Biden-era income-driven repayment program that reduced payments for eight million borrowers, remains stuck in limbo as a legal challenge continues, and the plan appears increasingly likely to be struck down or repealed. Earlier this month, the Trump administration effectively shut down the entire income-driven repayment application system, imperiling access to programs the federal government is legally required to offer. Last week, the U.S. Department of Education fired nearly half of its workforce, which observers warn may dramatically impact department operations and oversight of loan servicers. And just prior to that, President Donald Trump issued an executive order threatening to limit eligibility for the Public Service Loan Forgiveness program, or PSLF, which can benefit millions of nonprofit and government workers.
Now, a slew of proposed tax changes are threatening to make student loan repayment even more costly for borrowers. Republican lawmakers are working to put together a massive bill intended primarily to expand, extend and make permanent tax cuts that were enacted during the first Trump administration. But to offset the costs of those tax cuts, affirmative changes to the tax code that GOP lawmakers are proposing could directly harm student loan borrowers. Here’s a breakdown.
Student Loan Forgiveness May Become Taxable Again
Historically, any form of cancellation of debt – including most types of student loan forgiveness and discharges – can be a taxable event. That means borrowers who receive loan forgiveness or a discharge of their balance would be issued a Form 1099-C, a tax document that requires that the borrower report the amount of cancelled debt as “income” on their tax return. Borrowers would then have to pay income taxes on the cancelled debt, as if they had earned it in income that year.
The tax treatment of student loan forgiveness and discharge changed in recent years. In 2017, a Republican-led Congress and then-President Trump passed the Tax Cuts and Jobs Act, which – among other things – eliminated federal taxation for the Total and Permanent Disability discharge program, which offers student loan forgiveness to borrowers who are unable to engage in gainful employment due to a medical impairment. The law also exempted death discharges from federal taxation, as well. Then, in 2021, a Democratic-led Congress and then-President Biden passed the American Rescue Plan Act, which exempted all federal student loan forgiveness and discharges from federal taxation.
Both forms of tax relief are set to expire at the end of 2025. That means that, barring any action by Congress, federal student loan forgiveness and discharge programs that have been temporarily tax-free may go back to being taxable again starting next year, which could lead to significant tax liability for some borrowers. For example, if a $50,000 student loan balance is discharged, and the balance is taxed at an effective rate of 25%, that could result in a tax bill of over $12,000, due all at once. This could be particularly problematic for medically disabled borrowers who pursue the Total and Permanent Disability discharge program, as they may not have sufficient resources to pay for such large tax bills given their inability to work.
So far, lawmakers in the current Republican-led Congress have not provided any official indications that they intend on extending the expiring tax protections for student loan forgiveness, including for the TPD Discharge program (which Republicans and President Trump supported in 2017). Some borrowers may be able to reduce or eliminate tax liability associated with student loan forgiveness through other exemptions, such as insolvency, but not everyone would qualify.
Some profession-based student loan forgiveness programs, such as PSLF and Teacher Loan Forgiveness, have never been treated as taxable under the federal tax code. That shouldn’t change next year, unless Congress passes legislation to make them taxable.
End Of Student Loan Interest Tax Deduction
Republican lawmakers in Congress are considering a number of reforms to student loan forgiveness and repayment programs. Among them is eliminating the student loan interest tax deduction.
Under existing law, student loan borrowers can deduct up to $2,500 in interest that they paid on their student loans during the year. While this tax benefit is phased out for higher income earners, many lower- and middle-income borrowers can save on taxes (or get a larger tax refund) by claiming this deduction.
“Student loan interest is interest you paid during the year on a qualified student loan,” says IRS guidance. “It includes both required and voluntarily prepaid interest payments. You may deduct the lesser of $2,500 or the amount of interest you actually paid during the year. The deduction is gradually reduced and eventually eliminated by phaseout when your modified adjusted gross income (MAGI) amount reaches the annual limit for your filing status.” Qualifying student loan borrowers who paid at least $600 in interest would be issued a Form 1098-E by their loan holder or servicer, reflecting the amount of student loan interest paid during the year.
But to offset the costs of extending broad tax cuts, Republican lawmakers are contemplating ending this deduction, according to a House Budget Committee memo leaked earlier this year.
“Taxpayers can deduct up to $2,500 of interest paid on student loans from their taxable income,” says the memo. “This option would eliminate the deduction for student loan interest,” which the committee estimates would save $30 billion over the course of a decade – but would effectively raise taxes for lower- and middle-income borrowers who made payments on their student loans.
Tax Changes For Nonprofit Hospitals Could Cut Off Student Loan Forgiveness
Republican lawmakers are also considering another major tax code change that could have significant implications for federal student loan borrowers working in the healthcare field. The House Budget Committee memo also calls for eliminating the nonprofit status of hospitals.
“More than half of all income by 501(c)(3) nonprofits is generated by nonprofit hospitals and healthcare firms,” says the memo. “This option would tax hospitals as ordinary for profit businesses.”
Nearly five million Americans – including nurses, doctors, medical technicians, speech pathologists, physical therapists, and administrative staff – work for nonprofit hospitals and related organizations. Many of these borrowers are pursuing student loan forgiveness through PSLF. Under PSLF, borrowers can qualify for a discharge after making 10 years of qualifying payments while working in eligible public service employment. Eliminating the tax-exempt status of nonprofit hospitals and healthcare agencies could effectively derail loan forgiveness for these borrowers, in some cases years after they made professional and financial decisions based on the promise of relief through PSLF. Private-sector work generally does not qualify for PSLF, so these borrowers may have little recourse if this tax code change happens.
Student Loan Borrowers Could Be Taxed On Scholarships and Fellowships
Republican lawmakers in Congress are also considering imposing new tax burdens on students by taxing scholarships and fellowship income, which historically have been tax-free.
“Qualified scholarships and fellowships are generally excluded from taxable income if used for tuition and related expenses,” says the House Budget Committee memo. “This option would make all scholarship and fellowship income taxable, increasing revenue by $54 billion over 10 years.”
Taxing scholarship and fellowship income could raise costs for millions of students, including new college students as well as existing student loan borrowers returning to school to get a graduate or professional degree, or to complete a certificate program. Coupled with the loss of access to affordable income-driven repayment plans, and the additional tax burdens associated with student loan relief, these borrowers could be facing thousands of dollars in additional taxes, even if they take on no additional student loan debt, if the tax code change is enacted.
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