Will You Have to Pay Taxes on Canceled Student Debt?

If Your Student Loan Are Forgiven, Will You Owe Taxes on Them Next Year?

Widespread student loan forgiveness was announced for millions of borrowers. Here's what that means for next year's tax bill.



On Wednesday, President Joe Biden announced several student loan relief efforts -- most notably federal student loan forgiveness of $10,000 to $20,000 per borrower. With more than 43 million Americans holding federal student loan debt at approximately $37,667 per borrower (not counting private loans), many will see their debt balances diminish considerably, if not disappear entirely.

If your student loans are forgiven, either through the recent announcement, the Public Service Loan Forgiveness program or an income-driven repayment (IDR) plan, will you be required to pay taxes on the forgiven balances? Here's everything you need to know about student loans and taxes, as well as some additional tax breaks that could lower your tax bill in 2023.
Will you owe taxes on your forgiven student loan amount?

A provision tucked into the $1.9 trillion COVID relief package passed in March 2021 eliminates taxation on forgiven student loan debt through 2025. This means you won't owe any additional taxes on your forgiven student loans.

Typically when you receive student loan forgiveness, your forgiven debt is added to your taxable income come tax season. This increases the amount of taxes you owe for a given year, either lowering your refund or bumping up your tax bill.

For example, if you make $50,000 and have $20,000 in student loans forgiven, your taxable income would increase to $70,000, pushing you into a higher tax bracket.

For anyone who's just received forgiveness -- or will in the coming months -- your forgiven balance is tax-free.

Other tax considerations for those with student loans

In addition to student loan forgiveness options, you may be eligible for additional tax credits and deductions. Although 2023 tax thresholds have not yet been released, here are some student loan tax breaks that may boost next year's refund or lower your tax bill.
Student loan interest deduction

When you make monthly payments to your student loans, that includes your principal payment as well as any accrued interest payments. Whether you have private or federal student loans, the student loan interest deduction lets you reduce your taxable income, depending on how much interest you paid. For 2021, this reduction went up to $2,500 a year.

You're eligible for the deduction if you paid student loan interest in the given tax year and if you meet modified adjusted gross income requirements (your income after eligible taxes and deductions), For 2021, you qualified if your MAGI was less than $70,000 (or $100,000 if married, filing jointly). Partial deductions were offered for those with MAGI between $70,000 and $85,000 ($100,000-$170,000 for those who filed jointly).

With federal student loan repayments on pause and interest at 0%, you might not have paid any interest over the past year. That said, you should log into your student loan portal and check form 1098-E for any eligible interest payments.

If eligible, this deduction will lower your taxable income, which could reduce how much you owe the IRS or increase your tax refund. You might even get placed in a lower tax bracket, which could qualify you for other deductions and credits .
American Opportunity Tax Credit

The American Opportunity Tax Credit is available for first-time college students during their first four years of higher education. It allows you to claim 100% of the first $2,000 of qualifying education expenses, then 25% on the next $2,000 spent -- for a total of up to $2,500. If you're a parent, you can claim the AOTC per eligible student in your household, as long as they're listed as a dependent.

To claim the full credit in 2021, your MAGI must have been $80,000 or less ($160,000 or less for those married, filing jointly). If your MAGI was between $80,000 and $90,000 ($160,000 to $180,000 for those filing jointly), you might have qualified for a partial credit.

The AOTC is a refundable credit, which means if it lowers your income tax to less than zero, you might be able to get a refund on your taxes or increase your existing tax refund.
Lifetime Learning Credit

You can earn money back for qualified education expenses through the Lifetime Learning Credit. The LLC can help pay for any level of continuing education courses (undergraduate, graduate and professional degrees). Transportation to college and living expenses are not considered qualifying expenses for the LLC.

Unlike the AOTC, there's no limit to how many years you can claim the credit. You could get up to $2,000 every year or 20% on the first $10,000 of qualified education expenses. The LLC is not refundable, however, which means you can use the credit to lower your tax bill if you have one, but you won't get any of the credit back as a refund.

For 2021, you were eligible for this credit if you had qualifying expenses and your MAGI was less than $59,000 ($118,000 for those married, filing jointly). You could also claim a reduced credit if your MAGI was between $59,000 and $69,000 ($118,000 and $138,000 for those married, filing jointly).

Note: You cannot claim both the AOTC and the LLC for the same student in the same tax year. If you're eligible for both, the AOTC typically provides a bigger tax break (and can boost your refund).
If your loans are in default, will next year's tax return be garnished?

Normally, if you have federal student loans in default (meaning you're unable to pay what you owe on them for 270 days), your tax refunds can be taken to help cover the balance owed. Since federal student loans were on pause during the 2022 tax season, your federal tax refund was not eligible to be garnished by the government.

It's unclear if this will remain in place for 2023, though with the new payment pause set to expire at the end of 2022, this benefit may expire.
Your tax filing status can impact your student loan payments

If you're repaying federal student loans and you're on an income-driven repayment plan, your marriage status may impact your payment amount. For instance, if you're married filing jointly, your payments are based on the joint income between you and your spouse. If you're married filing separately, your payments are based on only your income.

If you decide to file separately to lower your monthly IDR plan payment, however, you may miss out on other key tax benefits. For example, you may not be able to take advantage of a lower tax rate extended to married couples filing jointly, nor will you be able to claim increased credit and deduction amounts available if you filing jointly.

The Revised Pay As You Earn, or REPAYE, plan doesn't distinguish between whether you're listed as married filing separately or married filing jointly. Your payments are based on the income of both you and your spouse.