Biden Plan Would Make Discharged Student Debt Tax-Exempt

• Temporary provisions excluded discharged debt from taxable income.
• Biden's proposal would make federal loan forgiveness tax-free.
• The proposed change would help those seeking forgiveness through repayment plans.

With Tax Day less than a week away, taxes are on the minds of many, including President Joe Biden.

He last month proposed a permanent change that would exempt all forms of student loan discharge and forgiveness from being included as taxable income. The proposal would set in stone previous temporary changes the federal government has put in place in recent years and would have major implications for income-driven repayment (IDR) plans.

Biden's administration included this tax proposal as part of an explainer for his 2023 budget proposal.

Up until five years ago, nearly all forms of student debt forgiveness came at a price.

Mark Kantrowitz, an author and student loan expert, told BestColleges that borrowers who sought loan forgiveness through programs including disability discharge and IDR plans saw the total amount of the forgiven debt treated as income by the Internal Revenue Service (IRS). That means the average borrower who received loan forgiveness for a $50,000 outstanding loan would owe approximately $10,000 after filing taxes.

Meanwhile, some debt forgiveness programs never treated discharge as taxable income. For example, those who got loans discharged through the Public Service Loan Forgiveness (PSLF) program never owed money to the IRS, Kantrowitz said.

Congress has enacted temporary changes to this tax code in recent years.

Kantrowitz said the Tax Cuts and Jobs Act of 2017 made loans forgiven through the disability or death discharge programs tax-exempt, but only temporarily. Biden broadened this to virtually all federal loans through the American Rescue Plan in 2021, which extended the exemption to IDR discharges for the first time.

However, the American Rescue Plan's waiver is set to expire on Jan. 1, 2026, meaning student debt discharged after then would once again be taxable.

Biden's newly proposed language would make the Rescue Plan's changes permanent. Kantrowitz said if enacted, all federal loan forgiveness programs would have tax-free status in perpetuity.

There are still many types of student loans not eligible for discharge through these programs, he added. For example, Parent PLUS loans aren't eligible for IDR or PSLF program forgiveness, while loans awarded through the Federal Family Education Loan program and Perkins loans don't qualify for PSLF without the limited waiver still in place.

Biden's office stated one of the reasons for the proposed change was that achieving conformity in loan discharge rules would eliminate the need for future legislative changes.

Additionally, Biden's office cited IDR plans specifically. Under these repayment plans, which have borrowers make payments based on earnings and discretionary income, someone is eligible for forgiveness after 20 or 25 years of payments. However, due to the low monthly payments, that means the debt could inflate during that time period as interest continues to accrue. Borrowers could then owe tens of thousands of dollars if the IRS treated that discharge as income.