The Cost of Forgiveness: Preparing Clients for Tax Implications of Student Loan Forgiveness

Chris Kadowaki, CHFC, CFP®, EA 
Avantax Financial Planning Analyst

Many students rely on loans to help cover the cost of education. In fact, the average public university student in 2024 borrows $32,362 to attain their bachelor’s degree. It’s no wonder why income-driven repayment options that qualify for loan forgiveness are an attractive option – but many don’t realize that this forgiveness can come with a surprise tax bill.

As their tax-intelligent Financial Professional, you can review the topics below to help your student-clients better understand their options and ultimately find the most suitable (and tax-efficient) loan and repayment options for their situation.

Private vs. Federal Loans

Let’s start with the basics. There are two options for student loan financing: federal government and private student loans. Federal student loans tend to be the more popular choice –  91.2% of all student loan debt in Q1 of 2024 was federal – but why? Well, many students prefer this option because 1) they can elect to have payments calculated based on their income and 2) unlike private loans, federal loans have standardized forgiveness programs.

This potential for student loan forgiveness comes only after making qualified payments for an extended amount of time – in many instances, after 10, 20, or 25 years of payments.

Tax Implications of Forgiveness

This is where you, their trusted financial professional, should don your tax-intelligent thinking cap (honestly, you should always be wearing it).

If your client chooses an income-driven repayment option that qualifies for forgiveness, the amount that’s forgiven may be taxable. In other words, the client’s relief over having their student loans forgiven may be short-lived if you don’t prepare them for their potential tax bill next tax season. Of course, the taxation rate and amount depend on the type of forgiveness your client qualified for and the client’s marginal tax rate. 

For example, if your client earns $100,000 per year and has $50,000 of their student loans forgiven, the taxable income on their next tax return will be $150,000. They’ll have to plan for the taxes they’ll pay for that additional $50,000 of “income” and, for an individual tax filer with no other income, this could amount to an additional $11,874 of federal tax owed.

Don’t forget: Depending on where your client resides, the state may tax the amount of their student loan forgiveness. 

Saving Now for Forgiveness Later

One of the most important aspects of your job as a financial professional is ensuring your clients aren’t surprised or unprepared. Consider talking to your student-clients about starting to save now for the tax bill that may come with potential student loan forgiveness. A taxable brokerage account or 529 account are a couple of tax-intelligent options to consider. 

Of course, student loans are only one part of your client’s financial picture. Be sure to consider how student loan forgiveness may impact their overall tax and financial situation. 

*This information applies to student loans rules as of the date of this writing but may be subject to changing legislation. Avantax exclusively provides financial products and services & does not directly provide or supervise tax or accounting services. Its affiliated Financial Professionals may offer those services through their independent outside businesses.