Guide to the Student Loan Tax Bomb: Starting in 2026

The Student Loan Tax Bomb: Why Forgiveness Could Become Taxable in 2026

If you’re counting on student loan forgiveness, there’s one big caveat: you might owe taxes. That ticking liability is what we call the Student Loan Tax Bomb. The federal exemption for forgiven federal student loans ends December 31, 2025 — if American Rescue Plan Act and other relief measures aren’t extended, any forgiveness obtained in 2026 or later could once again be treated as taxable income.

What is the tax bomb?

When a student loan is cancelled, the IRS typically treats the forgiven amount as income. For example, if you owed $30,000 and it was forgiven, you would be treated as receiving $30,000 of income — and taxed accordingly. Currently, federal law exempts forgiveness through 2025, but that window may close.
The key takeaway: forgiveness today may be tax-free at the federal level, but that won’t necessarily last — and your state law might treat it differently.

Why is federal forgiveness only temporarily tax-free?

Under the American Rescue Plan Act, the federal government made student loan forgiveness tax-free — but only for amounts discharged between 2021 and 2025. If Congress doesn’t pass new legislation, the exemption disappears on Dec 31, 2025. That means any forgiveness after that date — whether through Income‑Driven Repayment (IDR), Public Service Loan Forgiveness (PSLF), or Borrower Defense to Repayment — could be taxable.

States already taxing forgiveness

Even while the federal exemption is in force, some states do not automatically follow the federal rule. Five states currently tax forgiven student loans (with limited exceptions):

• Indiana – treats most forgiveness as income unless PSLF, teacher loan forgiveness, or disability discharge.
• Arkansas – taxes forgiveness unless under PSLF or permanent disability discharge.
• Mississippi – taxes forgiveness (except some CARES Act-related discharges).
• North Carolina – adds forgiven loans back into taxable income unless death/total disability.
• Wisconsin – taxes forgiveness unless PSLF, teacher loan forgiveness, National Health Service Corps, or disability discharge.
  If you qualify for Borrower Defense or IDR-based forgiveness, these states will likely treat your discharge as taxable income unless the specific exception applies.

Why all other states could tax you too (rolling conformity)

Here’s the nuance: beyond those five states, the majority of states follow either rolling conformity or static conformity to the federal tax code.

• Rolling conformity means a state automatically adopts changes in the federal tax code without separate state legislation.
• Static conformity means a state adopts the federal tax code as of a specific date and must enact new laws to adopt later changes.
  If a state uses rolling conformity, and if the federal exemption for student-loan forgiveness ends in 2025, then that state will also stop exempting the forgiven amount — meaning the tax bomb will go off statewide.
  If a state uses static conformity and never updated after the federal change, the old rule remains: forgiven student loans may be taxable.
  In short: even if you live in a state not already listed among the five, you could still face taxation. The safe assumption: forgiveness in 2026 or later may be taxable at both federal and state level unless your state legislature specifically acts to keep the exemption.

How this applies to IDR & Borrower Defense

If you’re working toward forgiveness through IDR — or applying for a discharge through Borrower Defense — you are on the risk clock. Those programs typically lead to debt discharge after many years (20-25 years for IDR; multi-year review for Borrower Defense).
Because of that extended timeline, many borrowers in these tracks may receive discharge in 2026 or later. That means the tax-exemption window may have expired. And if you live in one of the five states mentioned (or any state with rolling conformity), that discharge could be taxable.
For more on IDR forgiveness see our article “Your Comprehensive Guide to Home Buying with Student Loans”. For more on Borrower Defense see “How to File a Strong Claim"

What you can do now

1. Check your timeline: If you’re close to qualifying for forgiveness (10 yrs for PSLF; 20-25 for IDR) aim to hit discharge before 2026.
2. Research your state’s tax code: Determine whether you live in a rolling-conformity state or one with static law.
3. Consult a tax professional: Before a discharge hits your account — especially if you live in a “taxing” state.
4. Work with LoanSense: We estimate your timeline, monitor state law changes, and help you act before the window closes.

Bottom line

The “student loan tax bomb” is real — and you’ll want to act before the clock stops ticking. If your discharge happens in 2026 or later, you may owe taxes. Don’t assume “tax-free forgiveness” applies broadly. It may be time to act now.

You can always book a consult about your student loans but also get a FREE plan first! Lower your payments and access loan forgiveness here.