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  • Nathan Greene CFP®

Student Loan Forgiveness is Tax Free!... for now

The American Rescue Plan Act of 2021 excludes loan forgiveness from gross income until 2026.


On March 11, 2021, President Joe Biden signed the American Rescue Act of 2021 into law. Deep in the $1.9 Trillion COVID relief package Bill - section 9675 in fact - is a section titled "Modification of Treatment of Student Loan Forgiveness."


Before we dive into this modification, an important starting point is to remind you of the previous status quo. Normally, forgiven debt balances are treated as income to the borrower, just as if someone were to have paid the borrower enough money to eliminate their debt. That means in the year that the debt is forgiven, the borrower has to claim the full forgiven balance as taxable income (which for many borrowers, could mean an extra 6-figures - an amount that could push them into a materially higher tax bracket).


Now, there are a few loan forgiveness programs whose debt forgiveness is already excluded from income-tax, including:

-Public Service Loan Forgiveness (PSLF)

-Teacher Loan Forgiveness

-Loan forgiveness programs for nurses, doctors, and veterinarians

-Loan forgiveness programs for public interest law

-Death and disability discharges

-Closed school discharges

-False certification discharges (e.g., identity theft)

-Unpaid refund discharges.


However, the cancellation of debt resulting from the various Income-Driven Repayment (IDR) plans (including IBR, PAYE, RePAYE) after 20 or 25 years was taxable under previous law. THIS is the focal point of the new legislation; now this debt cancellation will not be reported as income!

But even that "good news" comes with a caveat. The Modification in Section 9675 of the American Rescue Plan Act of 2021 (read the entire Act here) states that "Gross income does not include any amount which (but for this section) would be includible in gross income by reason for the discharge (in whole or in part) after December 31, 2020, and before January 1, 2026..." (emphasis added). These dates are important.


This "tax free loan forgiveness" only applies to debt forgiven over the next 5 years. And considering that the Income Based Repayment Plan, the Pay As You Earn repayment plan, and the Revised Pay As You Earn repayment plan were all created after 2009, it's hard to see who might benefit from this Modification. In fact, it's highly likely that nobody reading this post stands to benefit from it.


To be a part of the very exclusive club that might benefit from this modification would require utilizing the Income Contingent Repayment plan ("ICR") - a largely overlooked option given the improved iterations of other IDRs in recent years. This ICR plan was created by legislation back in 1993 and offers debt cancellation after 25 years, meaning there are a few borrowers who will see forgiveness in this 5 year window. For those who will have spent slightly less than 25 years on the ICR, they may be able to switch to the RePAYE to qualify for the 20-year loan forgiveness, counting those years in ICR towards the 20-year requirement.


(A few astute readers might respond that RePAYE offers debt cancellation after 25-years rather than 20, as mentioned above, and that's correct too! But the RePAYE plan offers debt cancellation after 25-years for graduate school debt and after 20-years for undergraduate debt. This distinction further narrows the number of people who might benefit from this Modification.)


For everyone else, there is no direct benefit. The majority of people who elected to pursue these debt forgiveness options didn't do so until the programs truly caught on (with infrastructure development, better marketing, and generally improved-support from the Department of Education) - something that didn't happen until long after the IBR's creation in 2009. Since 2009 + 20 = 2029, the American Rescue Plan Act of 2021's modification deadline of 2026 misses the mark for most of everyone on an Income Driven Repayment Plan today.

So if it won't benefit anyone, why is this Modification important?


Because it opens a door.


Allow us to interpret some political intentions here: introducing this Modification, since it applies to so few people, adds very little to cost to the U.S. budget. But once the precedent is set, it is likely going to be easier to extend that window far beyond 2026 - potentially making it a permanent law.


So for those of you who are pursuing student loan cancellation through any of the Income Driven Repayment (IDR) plans (such as IBR, PAYE, RePAYE), don't get too excited just yet. This doesn't benefit you.


But be hopeful. The precedent is set, and you're likely in the queue.



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