Do I Have to Pay Taxes on PSLF Forgiveness?

After achieving loan forgiveness through the Public Service Loan Forgiveness (PSLF) program, many borrowers question if the forgiven amount is subject to federal or state taxes. This article clarifies the tax treatment of PSLF forgiveness and provides guidance on related issues.

The General Tax Rule for Debt Cancellation

The question of taxes on forgiveness arises from a general principle in tax law. The Internal Revenue Service (IRS) considers canceled or forgiven debt to be taxable income. This concept is known as Cancellation of Debt (COD) income, meaning the forgiven amount is treated as if you received that much cash.

For instance, if a credit card company agrees to let you pay $4,000 to settle a $10,000 balance, the $6,000 difference is considered taxable income. This default rule applies to many forms of debt, which is why specific exceptions in the tax code are necessary for certain types of forgiveness.

Federal Tax Implications of PSLF

For those who achieve loan forgiveness through the PSLF program, the forgiven amount is not considered taxable income by the federal government. This tax treatment is a permanent feature of the program established by Congress, which excludes student loan amounts discharged for individuals who worked in certain public service professions.

To qualify for PSLF, a borrower must make 120 qualifying monthly payments while working full-time for a qualifying employer, such as a government or 501(c)(3) non-profit. The tax exemption is directly tied to this service requirement, making the tax-free nature of PSLF a long-standing and specific exception for public servants.

State Tax Implications of PSLF

While PSLF forgiveness is not taxed at the federal level, state income tax implications require separate consideration. Most states practice “tax conformity,” meaning their tax laws follow the federal Internal Revenue Code. Because they adopt federal definitions of income, these states also do not tax student loan amounts forgiven under PSLF.

However, there are exceptions. Mississippi is known to tax PSLF forgiveness, which can result in a state tax liability for its residents. Because state laws can change, borrowers should verify the rules for their specific state of residence by checking with its Department of Revenue or equivalent tax agency.

Addressing a Form 1099-C for PSLF

A point of confusion can arise when a borrower receives a Form 1099-C, Cancellation of Debt, after PSLF forgiveness. Lenders use this form to report canceled debt to the IRS, but receiving one for PSLF is often an automated error. This form does not change the non-taxable nature of the forgiveness at the federal level.

If you receive a Form 1099-C for PSLF, do not report the amount as taxable income. Contact the loan servicer to request a corrected form showing $0 of taxable debt. If obtaining a corrected form is difficult, file your return without reporting the income and attach a statement explaining the amount is excluded due to Public Service Loan Forgiveness.