Written By Travis Hornsby, CFA®, CFP®
If President Biden wants to cancel debt, he’s racing against the clock thanks to student loan cancellation and forgiveness becoming taxable again very soon.
The American Rescue Plan made student loan forgiveness tax-free, but only until December 31, 2025. The 2024 election map will put taxation of student loan forgiveness in major jeopardy, and Senate and House Republicans might desire to extract significant concessions to extend the tax-free treatment of student loan forgiveness.
We’ll cover how this looming cliff influences President Biden’s efforts to cancel student loans and what this could mean for borrowers if forgiveness becomes taxable again.
How taxation of student loan forgiveness used to work
Before 2021, any student loan forgiveness outside of Public Service Loan Forgiveness (PSLF) would be taxed if your assets exceeded your income at the time of forgiveness.
For example, if you owed $100,000 in student loans but only had $50,000 of assets, you’d claim insolvency with the IRS and owe $0 in taxes.
However, if you used income-driven repayment (IDR) to get $100,000 of student loans forgiven and had $200,000 in assets, you’d need to count the $100,000 of forgiven debt as income using form 1099-C.
The American Rescue Plan eliminated that worry for borrowers. Student loan forgiveness and cancellation is tax-free between January 2021 and December 2025.
IDR forgiveness during this window has enjoyed the same tax treatment as PSLF, which has always been tax-free.
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What happens in 2026 with student loan forgiveness and cancellation
The American Rescue Plan passed on a party-line vote using budget reconciliation. Because of this legislative maneuver, some of the bill’s provisions had to have an expiration date.
One of these provisions is making student loan forgiveness tax-free. Technically, student loan forgiveness and cancellation become taxable income again starting in January 2026.
This tax-free forgiveness treatment of cancellation has been critical to the President’s student loan relief initiatives.
Why tax-free student loan forgiveness is critical to cancelling student debt
The PSLF waiver and the disability discharge have been tax-free for years.
However, canceling student debt by any other mechanism has been considered taxable income until 2021, when the American Rescue Plan changed this.
Even though the Supreme Court blocked Biden’s $400 billion cancellation program, he could never have tried it without making cancellation tax-free.
Imagine a struggling borrower receiving $20,000 of canceled debt but also getting a 1099-C declaring this $20,000 as income, on which they’d owe thousands of dollars in taxes.
The IDR waiver has forgiven tens of billions in student loans and counting.
Without tax-free forgiveness, a borrower getting $300,000 forgiven early would have had to count this as income with an enormous tax bill.
Cancellation could grind to a halt if it becomes taxable income again
President Biden has initiated Plan B forgiveness, which could go into effect no later than July 2025.
That’s only six months before forgiveness becomes taxable income again.
If canceling student debt carries a tax bill with it, he’d functionally be unable to cancel almost any debt with widespread action.
And Republicans know that.
How Republicans could block cancellation of debt by blocking tax-free forgiveness
Without tax-free cancellation, President Biden couldn’t discharge much of anything without hurting borrowers with a bigger tax bill than if they simply made their payments.
Consider the makeup of the 2024 Senate map, electorally.
With Sen. Joe Manchin in West Virginia not running again, it appears the Senate will be split with 50 Democrats and 50 Republicans.
If Republicans win the White House, they’ll control the Senate.
If they don’t win the White House, they’d only need to win one of Arizona, Montana or Ohio, and defend Texas, to win the Senate.
Even if Republicans lose the House, their strong chance of winning the Senate means they could effectively block any tax-free forgiveness of student loans by not renewing President Biden’s American Rescue plan provision that eliminated the “tax bomb” on student loans.
What if Republicans lose in 2024?
If Republicans lose both houses of Congress and the White House in 2024, Biden could do what he did in 2021 and simply extend the tax-free forgiveness of student loans without Republican help.
Budget reconciliation is not subject to the filibuster, so if you see Democrats sweep the 2024 elections, you could feel good about the broad prospects for more forgiveness and cancellation.
What would Republicans do if asked to trade tax-free forgiveness for something else?
Lawmakers frequently trade a vote on one policy for a vote on another policy.
The student loan system has many problems, and Republicans might want to avoid angering constituents who receive IDR forgiveness over 20 or 25 years as this ramps up in the coming years.
Hence, Congressional Republicans might be inclined to extend tax-free forgiveness treatment in exchange for capping PLUS loans, reducing the generosity of the Saving on a Valuable Education (SAVE) plan or something else entirely, such as keeping some tax breaks that also expire in 2026 when the Tax Cuts and Jobs Act ends.
Biden will race to cancel as much debt as possible before the cliff
President Biden and his team view cancellation and student debt relief as a key part of his reelection strategy.
Student debt is a proxy for energizing younger voters, and he has every incentive to try to cancel as much debt as possible, as many of the charges of debt cancellation don’t have to be paid for from spending reductions or tax cuts like other budgetary items.
Republicans have watched on the sidelines while President Biden has canceled more student debt than any President in history. The tax-free treatment of debt cancellation has been critical in this attempt.
While Biden was unsuccessful in broad, massive cancellation, he still canceled well over $100 billion of student loans.
And Republicans will see eliminating tax-free forgiveness as an easy way to stop him from enacting policies they don’t approve of.
So, expect lots of efforts in 2024 (and 2025 if Biden wins) to run up the cancellation totals as much as possible.
Not sure what to do with your student loans?
Take our 11 question quiz to get a personalized recommendation for 2024 on whether you should pursue PSLF, Biden’s New IDR plan, or refinancing (including the one lender we think could give you the best rate).
