Up to $20,000 in Student Loan Cancellation is Here: But Will it Hurt Your Taxes?

President Biden made a long-awaited announcement extending the more than two-year-old pause on student loan payments through the end of this year. The Federal government will also provide student loan debt cancellation of up to $10,000 per borrower, within specific income limits, and up to $20,000 for Pell Grant recipients. To be eligible for forgiveness, student loans must be held by the Department of Education.

The information came August 24, a week before the current pause on student loan payments was scheduled to expire. And while some borrowers will welcome the news of the student loan payment pause extension and student loan forgiveness, the latter raises an important question. Will student loan cancellation hurt your taxes?

The short answer to whether you will pay federal income taxes on student loan forgiveness is no. And that' more good news for the millions of borrowers who will be eligible for student loan relief under President Biden’s plan. But it's still helpful to know why the student loan relief won’t be taxable to you.

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2022 Student Loan Cancellation

Under President Biden's student loan debt cancellation plan, the Department of Education will provide student loan relief up to $10,000 to borrowers whose loans are held by the Department of Education, and whose income is less than $125,000 per year. For married couples who file jointly, the student loan cancellation income limit is $250,000. (Each spouse will be eligible for up to $10,000 in student loan cancellation). For Pell Grant recipients, student loan relief of up to $20,000 is available.

The White House says that those income limits are designed to prevent high-income individuals or households (i.e., the top 5% of incomes) from benefiting from the broad student loan relief program.

Normally though, no matter your income level, the IRS treats cancelled and forgiven debt as taxable income. As a result, in the past, you would have to pay taxes on the amount of your debt that was forgiven. But thankfully, for the millions of borrowers who may have a portion (or all) of their student loan cancelled under President Biden’s plan, there are some important exceptions to the normal IRS rule that have applied recently to student loans.

For example, student loan borrowers whose loans are forgiven as part of the Public Service Loan Forgiveness program, are currently exempt from tax on the forgiven amounts. (Eligibility for that program has recently been expanded.)

Also, the American Rescue Plan Act (ARPA), which was enacted during the COVID-19 pandemic, paused taxes on student loan forgiveness from 2021 through 2025. That includes people whose student loans are classified under the Income-Driven Repayment program. ARPA's broad relief covers other repayment programs, effectively making student loan forgiveness nontaxable for most borrowers.

On Wednesday, the White House confirmed that because of the student loan relief provisions in ARPA, the 2022 loan cancellation amounts will be nontaxable for federal income tax purposes. That means that the amount of student loan forgiveness won’t be added to your taxable income—at least through 2025.

The Department of Education will provide more information on the 2022 student loan debt cancellation program in the coming weeks. In the meantime, additional details can be found on the Department of Education’s website.

What about state income tax? It should be noted that most states will follow the Federal government on whether the student loan debt forgiveness is taxable. But stay tuned: there may be some states that consider the loan cancellation amount to be taxable, which could impact your state tax bill.

Student Loan Pause Extension

Although you won’t be taxed on the amount of student loan cancellation you receive under President Biden’s plan, student loan payments are scheduled to resume in January 2023. As you may know, student loan payments were first paused in March 2020 to provide relief at the beginning of the COVID-19 pandemic. That payment pause has been extended numerous times since then—the most recent pause was scheduled to expire on August 31.

So, for the last couple of years, you haven’t been paying interest on your student loans. But in 2023, you’ll likely return to making your normal student loan payments with interest. From a tax perspective, that might not be all bad because of the student loan interest deduction.

When you pay interest on your student loan, the IRS allows you to deduct either the amount of interest you paid during a given tax year, or $2,500, whichever is less. And, you don’t have to itemize your deductions to claim student loan interest because the IRS considers that interest to be an adjustment to your income.

But whether you can claim a deduction for student loan interest depends on several other factors including on your filing status and income.

So, when your student loan payments resume in January, remember that you may be able to get a tax break by deducting any student loan interest that you might pay in 2023. You can learn more about how to claim the student loan interest deduction by visiting the IRS’s website. You can also see Student Loans and Taxes: Basics to Know.