Major Tax Shift for US Student Loan Borrowers
As the year 2025 approaches its conclusion, millions of Americans with education debt are confronting significant changes to how their student loans are treated for tax purposes. A crucial federal law that has protected borrowers from paying taxes on forgiven student loan amounts is set to expire at the end of 2025. Simultaneously, the government has restarted the practice of seizing tax refunds from those who have defaulted on their loans.
More than 40 million Americans collectively hold over $1.6 trillion in student loan debt, making these policy changes a matter affecting a substantial portion of the population. Borrowers could soon find themselves with an unexpected federal tax bill or a reduced tax refund, directly resulting from these shifts in policy under the current administration.
Essential Steps to Navigate the New Tax Landscape
1. Document Your Forgiveness Eligibility
For any borrower anticipating student loan forgiveness in 2025, meticulous record-keeping is now more critical than ever. You should gather and organize all payment records and any correspondence with your loan servicer. Nancy Nierman, assistant director of the Education Debt Consumer Assistance Program in New York, emphasized the importance of this step in a conversation with CNBC. She advised that this documentation may be necessary to prove that the forgiveness was entitled during a period when it was not subject to federal taxation.
2. Prepare for Potential State Tax Bills
Even if you successfully receive loan forgiveness this year and avoid federal taxes, your state might still impose a tax on the relieved amount. Mark Kantrowitz, a recognized higher education expert, identified several states that tax certain types of forgiven student loans. Arkansas, Indiana, Mississippi, North Carolina, and Wisconsin are among those that may present a tax bill for forgiven debt. Kantrowitz strongly recommends that borrowers verify their specific state's regulations to avoid any financial surprises.
3. Maximize Your Student Loan Interest Deduction
A valuable benefit remains available for borrowers: the ability to deduct up to $2,500 in student loan interest payments from their taxable income each year. This applies to both private and federal student loans. Kantrowitz explained that for 2025, this deduction could be worth as much as $550, depending on the borrower's tax bracket. The advantage of this deduction is that it is an "above-the-line" adjustment, meaning you can claim it without needing to itemize your deductions. It is important to note that income limits apply; the deduction begins to phase out for single filers with a modified adjusted gross income of $85,000 and for married couples filing jointly at $170,000. Lenders typically provide a Form 1098-E to report the interest paid, but borrowers should proactively request it if they do not receive one by January.
4. Avoid Tax Refund Seizure by Getting Current
The Internal Revenue Service (IRS) has resumed its policy of offsetting tax refunds for borrowers who are in default on their federal student loans. This means your entire refund, including any refundable tax credits, can be taken to repay the defaulted debt. With over five million borrowers currently in default, this is a pressing concern. Kantrowitz noted that bringing your loan account current is the most effective way to stop this Treasury offset. Options for getting out of default include enrolling in an income-driven repayment plan or completing a loan rehabilitation program. As a proactive measure, borrowers can also adjust their paycheck withholdings to minimize the size of their annual tax refund, thereby reducing the amount that could be seized, though this must be done in strict compliance with IRS guidelines.
Proactive Planning is Key
These four strategic steps—organizing records, understanding state tax liabilities, utilizing interest deductions, and addressing loan defaults—provide a clear roadmap for US student loan holders. By taking these measures before the end of 2025, borrowers can navigate the evolving federal and state tax obligations with greater confidence and significantly reduce the risk of unwelcome financial surprises from the IRS.
