A small but significant provision was added to the $1.9 trillion stimulus package that just passed through Congress — also known as the COVID-19 Relief Bill or the American Rescue Plan — which makes student loan forgiveness free from federal taxation through 2025.

This provision can potentially save American student loan borrowers thousands of dollars in taxes if they receive all or partial forgiveness on their student loans. Here’s who can benefit from the provision and how much they can save.

Student loan forgiveness becomes tax-free through 2025

Led by Democratic senators Elizabeth Warren and Bob Menendez, the Student Loan Tax Relief Act was introduced on March 1, 2021, as a provision of the American Rescue Plan. The stimulus package passed through Congress on March 10, 2021.

Through this provision, borrowers whose student loans are forgiven will no longer be responsible for paying taxes on the canceled amount from 2021 to 2025, says Curtis Campbell, president of TaxAct. “This means instead of reporting the forgiven student loan debt as income on their taxes, as typically required, a person who has already signed up for income-driven repayment plans and expects those student loans to be forgiven, will not have to pay income taxes on that forgiven debt for the next five years.”

Before the stimulus package, any student loan debt that was forgiven through income-driven repayment plans was considered taxable, leaving borrowers with a large bill even after seeing debt wiped away.

Borrowers on income-driven repayment plans will benefit most

The loans that are eligible for tax-free forgiveness include all federal student loans, federal parent loans, state education loan programs, loans provided by a college or university, private student loans and private parent loans. While some forms of student loan discharge are already nontaxable, this move benefits borrowers pursuing forgiveness through an income-driven repayment plan, who were previously subject to a tax.

Stacey MacPhetres, senior director of education finance at Bright Horizons EdAssist Solutions, does point out that the history of forgiveness under the current income-driven programs is low, and borrowers will still need to meet the 20 or 25 years’ worth of payments in order to qualify for tax-free forgiveness before Jan. 1, 2026. However, for those who qualify, this provision has the potential to save borrowers thousands of dollars come tax season.

Joe DePaulo, CEO and co-founder of College Ave, agrees about the financial benefits: “There’s no doubt the pandemic has had a financial impact on many families. The recent passing of student loan forgiveness as tax-free can help those families facing financial hardship.”

The stimulus package sets the stage for student loan cancellation

Progressive Democrats, like Warren and Menendez, are putting increased pressure on President Biden to enact an executive order to cancel student loan debt. Congressional Democrats have been pushing for Biden to cancel $50,000 in student loans per borrower, but the president favors a much lower $10,000 amount instead.

While the stimulus bill provision does not include any direct loan forgiveness, it does leave progressive Democrats hopeful that this will nudge President Biden in the direction of mass student loan cancellation, since any measures will no longer have tax implications for borrowers.

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