Can You Opt Out of Student Loan Forgiveness?

A lawsuit initially caused the Department of Education to say that borrowers could opt out of student loan forgiveness. But will it matter after the Supreme Court weighs in?

Yes and no written on black chalkboard
(Image credit: Getty Images)

Legal challenges have been against President Biden’s student loan forgiveness plan since it was introduced last year. The plan was to offer up to $10,000 of student loan debt relief for eligible borrowers, and up to $20,000 in student loan forgiveness for Pell Grant recipients. Two of those legal challenges have made their way to the U.S. Supreme Court, who will ultimately decide whether the Biden Administration has the legal authority to forgive any student loans. In the meantime, it’s unclear whether you can still opt out of student loan forgiveness–something the Department of Education said that you could do last year. 

Why You Could Opt Out of Student Loan Forgiveness

The idea that you could opt out of student loan forgiveness came from the very first student loan debt relief lawsuit. That case was brought by the Pacific Legal Foundation, a libertarian group in California. The organization argued that student loan borrowers in states that could or will tax forgiven student loan debt would be worse off than other borrowers, because of Biden’s student loan forgiveness. However, the Department of Justice said that federal student loan forgiveness doesn’t create an “automatic” tax penalty because borrowers aren’t required to have their student loans forgiven.

Why does this matter? Well, the Pacific Legal Foundation’s challenge raised important questions concerning states that will or might tax forgiven student loan debt (you might live in one of them), and whether you have to accept student loan debt forgiveness.

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The lead plaintiff in the student loan debt relief case was a Pacific Legal Foundation attorney, Frank Garrison. Garrison argued that an Indiana state tax on forgiven student loan debt would amount to immediate tax liability and an unfair penalty. As an Indiana taxpayer, he asked the court to invalidate President Biden’s student loan debt cancellation program and pointed to at least six other states where, Garrison said, borrowers could be similarly harmed.

The federal government responded to the lawsuit by saying that borrowers, who are eligible for so-called “automatic” debt relief, could opt out of Biden’s student loan forgiveness plan, and avoid paying state taxes on the canceled debt. In other words, “you can keep you student loan debt—if you want to.”

As a result of the opt-out, a federal judge denied Pacific Legal Foundation’s motion to block President Biden’s student loan forgiveness and dismissed the organization's claim.

But this case means that going forward, it could be difficult for a borrower to claim that state tax has been unfairly or automatically imposed merely because of Biden’s student loan relief. The student loan forgiveness opt out basically allows the federal government to say that the borrower chooses whether to have forgiven student loan debt in the first place. That would make any tax “penalty” a state issue.

Another challenge with this case is that the lead plaintiff, Garrison, hadn’t yet paid any state tax on forgiven student loan debt. So, it was unclear whether there’s sufficient legal harm to justify stopping President Biden’s student loan forgiveness program. However, that could potentially change if student loans are forgiven and some states impose tax liability on the cancelled debt.

Will Your State Tax Forgiven Student Loan Debt?

You may be wondering why someone would want to decline $10,000 to $20,000 of student loan debt forgiveness. There could be many reasons, but this particular legal case pointed to the idea that borrowers in states that will or could tax student loan forgiveness might not want to pay additional state taxes.

Right now, whether some states will tax forgiven student loans (if the Supreme Court doesn’t strike down the plan) is an evolving situation. A few states have confirmed that they will tax canceled student loan debt.  In Indiana (where the lead plaintiff in the Pacific Legal Foundation case reportedly resides), the potential tax on $10,000 of forgiven student loan debt could be as high as $1,000.

If you live in Mississippi, as another example, the maximum amount of state tax liability could be $500. However, those calculations assume that you are eligible for the full $10,000 of loan forgiveness for individuals with income under $125,000 a year. And if you are a Pell Grant recipient in a state that could or will tax forgiven student loan debt, and are eligible for up to $20,000 in student loan relief under President Biden’s plan, your state tax liability could be higher.

There are other states that could or will tax forgiven student loan debt. However, as of now, if student loan forgiveness goes forward, most states plan to conform to the Federal government’s stance that most forgiven student loan debt is not taxable through 2025.

How to Apply for Student Loan Forgiveness

Applications for Student Loan Forgiveness are on hold. Previously, on its website, the Department of Education had said that  if borrowers wanted to opt out of student loan debt relief for any reason, that they would be given an opportunity to do so. However, given the lawsuits over student loan relief  at the Supreme Court, it’s unclear at this point, exactly how opting out of student loan debt relief will work or whether it will be relevant at all.

Stay tuned to Kiplinger for updates on student loan forgiveness and sign up for updates from the U.S. Department of Education if you have any questions.

Kelley R. Taylor
Senior Tax Editor,

With more than 20 years of experience as a corporate attorney and business journalist, Kelley R. Taylor has contributed to numerous national print and digital magazines on key issues spanning education, law, health, finance, and tax. Over the years, Kelley has extensively covered major tax developments and changes including the TCJA, pandemic-era changes in ARPA, the SECURE 2.0 Act, and the numerous clean energy tax credits in the Inflation Reduction Act. Kelley particularly enjoys translating complex information in ways that help empower people in their daily lives and work.