📌 Today's Thing: The return of the student loan forgiveness tax

In last week’s edition, I covered the new opportunity in President Trump's "One Big, Beautiful Bill Act" (OBBBA) — the sweeping legislative package that reshaped a lot of domestic tax policy — for student loan borrowers to deduct up to $2,500 in annual interest payments from adjusted gross income. The other side of the interest portion of loan payments is the outstanding principal.

If you have been patiently making income-driven repayment (IDR) plan payments and counting down the years until your remaining federal student loan balance is wiped clean, here is a development that deserves your full attention before 2026 gets any further along: that long-awaited moment of debt cancellation is now almost certainly going to come with a Federal income tax bill attached to it. And depending on the size of your forgiven balance, we are not talking about a rounding error — we are talking about a potential five-figure obligation that could reshape your financial picture for the entire year, and beyond.

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According to reporting by Kate Dore of CNBC.com, many student loan borrowers who receive debt forgiveness in 2026 can expect a significant tax bill in the spring of 2027. The reason: a provision of the American Rescue Plan Act of 2021 that temporarily shielded most federal student loan forgiveness from taxation at the federal level expired on December 31, 2025.

The sweeping scope of the OBBA did not extend or make permanent the student loan forgiveness exclusion from taxable income. The result is that borrowers who had their debt canceled under Biden-era programs, or who receive IDR forgiveness beginning January 1, 2026, are generally back in taxable territory.

To understand why this matters so much from a tax standpoint, it helps to know where the law lives. Under §61(a)(11) of the Internal Revenue Code², "discharge of indebtedness" is explicitly included in the definition of gross income. That means when a creditor — including the Federal government — cancels or forgives a debt you owe (and by extension your immediate family in some states), the forgiven amount is treated as income to you in the year it is discharged, subject to ordinary income tax rates.

Congress has carved out specific exclusions from this rule over the years, most of which are found in IRC §108 which is about all sorts of debt cancellation³. The most relevant for student loan borrowers are:

(1) the insolvency exclusion under §108(a)(1)(B), which allows you to exclude forgiven debt from income to the extent your total liabilities exceeded your total assets immediately before the discharge; and

(2) the now-expired American Rescue Plan Act exclusion, which was a temporary provision running from January 1, 2021 through December 31, 2025, covering most categories of federal and certain private student loan forgiveness.

With that window now closed, IRC §61 is back in full force for IDR forgiveness. On the regulatory side, the Code of Federal Regulations reinforces this framework. Treasury Regulations at 26 CFR §1.61-12(b)(2) confirms that the amount realized from the cancellation of debt constitutes gross income⁴. Any borrower approaching IDR forgiveness should be familiar with these provisions — or at minimum, working with a tax professional who is.

The Biden Administration's American Rescue Plan Act of 2021 made a sweeping change to the taxation of student loan forgiveness: for a five-year window ending December 31, 2025, virtually all forms of federal student loan cancellation were excludable from federal income tax. Borrowers who reached their 20- or 25-year IDR forgiveness milestone during this period, or who received relief under broad Biden-era cancellation programs, avoided what some policy advocates had long called a "tax bomb." For many borrowers, that protection meant the difference between a clean slate and an immediate five-to-six-figure tax liability.

Last summer's tax law, the One Big, Beautiful Bill Act (OBBBA) did not renew that protection. While the legislation overhauled a number of other provisions of the tax code, the student loan forgiveness exclusion was not among its priorities. According to reporting on February 23rd by CNBC’s Kate Dore, the most impacted borrowers will be those whose debt is canceled under IDR plans — programs such as Income-Based Repayment (IBR), Pay As You Earn (PAYE), Saving on a Valuable Education (SAVE), and Income-Contingent Repayment (ICR) — which erase remaining balances after 20 or 25 years of qualifying payments, respectively. With large cohorts of borrowers now entering the forgiveness phase of these plans, the timing could not be more consequential.

Importantly, not every type of student loan forgiveness has lost its tax-free status. Under current law, the following categories remain excludable from federal gross income:

•       Public Service Loan Forgiveness (PSLF) — excludable under existing statutory authority.

•       Teacher Loan Forgiveness — specifically excluded by statute.

•       Total and Permanent Disability (TPD) Discharge — excluded under IRC §108(f)(4).

•       Borrower Defense to Repayment discharges — currently treated as non-taxable, though practitioners should monitor any regulatory guidance.

This is not a theoretical concern for a small subset of borrowers. According to Dore's CNBC reporting, the Trump administration recently confirmed it had identified more than 40,000 borrowers eligible for federal student loan forgiveness in January 2026 alone. Financial advisors quoted in the piece warned that large balances are going to be forgiven over the coming months and years — and that the resulting tax liability could thrust some borrowers into higher tax brackets they had not budgeted for.

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If you are on an IDR plan and approaching — or already past — your forgiveness milestone, here are the steps that matter most right now:

•       Determine your forgiveness year. One helpful rule of thumb: if your final IDR payment was made in 2025, you likely avoided the tax. If your forgiveness falls in 2026 or later, plan for taxable income.

•       Estimate the forgiven amount. Your loan servicer can provide an estimated payoff balance. That figure, if forgiven in 2026, will be reported to you on IRS Form 1099-C (Cancellation of Debt) in January 2027.

•       Consult a tax professional sooner rather than later. The planning window for 2026 forgiveness events is narrow. Understanding how forgiveness may interact with other deductions — are best pursued before the discharge occurs.

If these options don’t fit your situation, you may want to consider reaching out directly to the IRS and apply for an Offer in Compromise. This program allows a taxpayer to settle your tax debt for less than the full amount owed. In an environment of legal frameworks changing every four years, an offer in compromise may be a viable if you can't pay the tax due on the entire amount forgiven, or doing so creates a financial hardship.

The temporary reprieve from the student loan forgiveness tax is over. The combination of the American Rescue Plan Act’s expiration date of December 31, 2025, and the OBBBA's silence on the issue means that IDR borrowers receiving forgiveness in 2026 and beyond are squarely back under IRC §61(a)(11). The forgiven balance shall be gross income. Plan accordingly.

Tax Clarity Newsletter will continue tracking regulatory guidance from the IRS and Treasury Department on this issue, including any forthcoming guidance on insolvency procedures and Form 1099-C reporting requirements for servicers. If you have questions about how your specific forgiveness scenario interacts with current law, this is exactly the kind of issue where a qualified tax professional can save you significantly more than their fee.

There's the scoop, everyone!

Thanks for taking time to check out the exclusive subscriber edition of the Tax Clarity Newsletter on beehiiv. Thank you so much!

References

¹ Kate Dore, Student loan forgiveness is taxable again. How to plan for a five-figure IRS bill, CNBC, February 23, 2026, accessed February 26, 2026.

² IRC §61(a)(11), Gross Income Defined — Income from Discharge of Indebtedness.

³ IRC §108, Income from Discharge of Indebtedness.

⁴ Treas. Reg. §1.61-12(b)(2), Treasury Regulations on cancellation of indebtedness income.

⁵ Pub. L. No. 117-2, 135 Stat. 9 at 185, American Rescue Plan Act of 2021, § 9675, Modification of Treatment of Student Loan Forgiveness.

DISCLAIMER: The information in this newsletter is derived from public information, provided for educational purposes. It is not provided as a financial advisory service and should not be relied upon as such. For advice on a specific tax matter, please consult a tax professional.