A Looming Threat: Proposed Tax Changes Possibly Impacting Student Loan Forgiveness and Repayment
Substantial Tax Alterations Aimed at Student Loan Debtors May Prove Disastrous
Millions of student loan borrowers are grappling with an unsettling repayment landscape beset by turmoil. Now, a fresh challenge looms on the horizon—potential revisions to the federal tax treatment of student loan forgiveness and repayment. These changes could significantly impact numerous Americans with student debt.
Student loan borrowers face an array of challenges currently. The SAVE plan, a repayment program aimed at reducing payments for eight million borrowers, remains in limbo, as a legal challenge persists, suggesting it may be struck down or repealed. Earlier this month, the Trump administration effectively shuttered the entire income-driven repayment application system, jeopardizing access to programs the federal government is required to offer. Last week witnessed the U.S. Department of Education dismissing nearly half of its workforce, reportedly impacting department operations and oversight of loan servicers. A week prior, President Donald Trump issued an executive order limiting the eligibility for the Public Service Loan Forgiveness program, which can benefit millions of nonprofit and government workers.
Now, a series of proposed tax modifications pose a threat to make student loan repayment even more burdensome for borrowers. Republican legislators are working on a considerable bill primarily focused on extending and making permanent tax cuts enacted during the first Trump administration. But the costs of these tax cuts necessitate compensatory adjustments to the tax code, which these lawmakers are proposing could negatively impact student loan borrowers. Here's a breakdown.
The Return of Taxable Student Loan Forgiveness
Traditionally, cancellation or discharge of debt, including most forms of student loan forgiveness, can be considered a taxable event. This means that borrowers receiving loan forgiveness or discharge of their balance would need to report the amount of cancelled debt as "income" on their tax return. Borrowers would then be required to pay income taxes on the cancelled debt, as if it were earned income that year.
The tax treatment of student loan forgiveness changed recently. The Tax Cuts and Jobs Act passed in 2017 eliminated federal taxation for the Total and Permanent Disability discharge program and death discharges. Then, in 2021, the American Rescue Plan Act 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. should these protections not be extended by Congress, federal student loan forgiveness and discharge programs that have been temporarily tax-free may revert to being taxable again starting next year. This could potentially lead to substantial tax burdens for several borrowers.
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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.
Profession-based student loan forgiveness programs, such as the Public Service Loan Forgiveness program and Teacher Loan Forgiveness, have never been considered taxable under the federal tax code. That shouldn't change next year, unless Congress passes legislation to make them taxable.
End of the Student Loan Interest Tax Deduction
Republican lawmakers in Congress are mulling over several reforms to student loan forgiveness and repayment programs, one of which is the elimination of the student loan interest tax deduction.
Under the current legislation, student loan borrowers can deduct up to $2,500 in interest paid on their student loans during the year. This tax benefit is phased out for higher income earners, but many lower- and middle-income borrowers can save on taxes (or receive a larger tax refund) by claiming this deduction.
"Student loan interest is interest that you paid during the year on a qualified student loan," says IRS guidance. "It includes both required and voluntarily prepaid interest payments... 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."
By eliminating this deduction, Republican lawmakers could save $30 billion over a decade according to an earlier House Budget Committee memo, but this would essentially raise taxes for lower- and middle-income borrowers who made payments on their student loans.
Tax Changes for Nonprofit Hospitals May Hurt Student Loan Forgiveness
Republican lawmakers are also considering a significant tax code change that could have significant consequences for federal student loan borrowers working in the healthcare field. The House Budget Committee memo calls for eliminating the tax-exempt 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 if they were for-profit businesses."
Almost five million Americans working for nonprofit hospitals and related organizations could be affected by this change, including nurses, doctors, medical technicians, speech pathologists, physical therapists, and administrative staff. Some of these borrowers are pursuing student loan forgiveness through the Public Service Loan Forgiveness program. Should this tax status alteration occur, loan forgiveness for these borrowers could be compromised, potentially Years after they made career and financial choices based on the promise of relief through PSLF. Private-sector work does not qualify for PSLF, making these borrowers unlikely to have viable alternatives if this tax code change takes effect.
Student Loan Borrowers Could Face Taxation of Scholarships and Fellowships
Republican lawmakers in Congress are contemplating imposing additional tax burdens on students by taxing scholarship and fellowship income, which historically has 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 going back to school for a graduate or professional degree, or to finish a certificate program. Coupled with the loss of access to affordable income-driven repayment plans and the additional tax liabilities associated with student loan relief, these borrowers could be facing large tax bills even with no additional student loan debt, if this tax code change is enacted.
- In 2025, the tax exemption for certain federal student loan forgiveness programs, such as Total and Permanent Disability discharge and death discharges, will expire if not extended by Congress, potentially making these types of forgiveness taxable again.
- The proposed elimination of the student loan interest tax deduction could affect millions of lower- and middle-income borrowers, as they would no longer be able to deduct up to $2,500 in interest paid on their student loans during the year.
- A potential tax code change being considered by Republican lawmakers could lead to the taxation of scholarships and fellowships, increasing the costs for millions of students who rely on these funds for education expenses. This tax change could be particularly burdensome for student loan borrowers, as it comes at a time when they may also face additional tax liabilities associated with student loan relief.
