Student loan 'tax bombs' are back: What advisors need to know

Core Insights - Clients expecting significant student loan forgiveness in 2026 may face unexpected tax liabilities due to the expiration of the American Rescue Plan Act of 2021, which previously exempted forgiven federal student debt from taxation [1][2] Tax Implications - Under the reinstated tax rule, canceled student debt is considered ordinary income, potentially leading to substantial tax bills. For an average forgiven balance of $57,000, federal taxes could range from approximately $7,000 to over $12,000, depending on the borrower's tax bracket [2] - The additional income from forgiven loans may elevate clients into higher tax brackets or trigger phaseouts of essential credits and deductions [2] Exceptions to Tax Liabilities - Certain borrowers may avoid tax implications if they qualified for forgiveness in 2025 but had their discharges delayed into 2026 for administrative reasons. Public Service Loan Forgiveness remains fully tax-exempt [3] Financial Planning Strategies - With the tax exemption removed, loan forgiveness should be viewed as a significant tax event rather than merely a financial benefit. Advisors are encouraged to conduct a "lowest total cost" analysis to determine if income-driven repayment forgiveness remains the most cost-effective option [4] - Despite potential tax bills, pursuing forgiveness may still be more beneficial in the long run compared to repaying the full debt. Advisors can add value by performing this analysis for clients [5] Timing and Payment History - The timing of loan forgiveness is crucial, as the tax bill is incurred in the year the loan is discharged. Advisors need to model the specific year of forgiveness, which has become more complex due to the removal of tracking tools on StudentAid.gov [5] - To assist clients, advisors must manually reconstruct payment histories and audit servicer records to determine qualifying months, allowing clients to adjust tax withholdings or estimated payments proactively [6]