Student loan borrowers in Illinois could face federal, state ‘tax bomb’
in 2026
[January 31, 2026]
By Sam Freeman and Medill Illinois News Bureau
SPRINGFIELD — For the first time in five years, certain forms of student
loan forgiveness will be taxable following a change in federal tax
policy this year.
This comes after a provision of the American Rescue Plan Act expired
Dec. 31. That measure, signed into law in 2021 by former President Joe
Biden, temporarily excluded student loan debt from federal income taxes.
And those tax implications could extend to Illinois state taxes as well
unless lawmakers act.
President Donald Trump’s “One Big Beautiful Bill Act,” enacted last
summer, did not make the student loan tax forgiveness provision
permanent. As a result, student loans that are canceled or partially
forgiven in 2026 and beyond will see taxes owed on those forgiven
amounts, advocates said. These taxes could amount to as much as $10,000,
depending on the borrower’s income.
This includes income-driven repayment plan-related forgiveness; some
closed school discharges — where 100% of a student loan obligation is
wiped out if a school closes — and private settlements. Meanwhile, some
forms of loan forgiveness remain tax-free, such as public service loan
forgiveness, teacher loan forgiveness, and death and disability
discharge programs.
According to a report from Protect Borrowers, a nonprofit organization
dedicated to eliminating the burden of student debt, two-thirds of
people who receive loan cancellation under income-driven repayment plans
earn less than $50,000 a year and have less than $1,000 in savings.
“A tax bomb on people with that amount of assets and that amount of
income, it could be really financially devastating,” said Jennifer
Zhang, a researcher for Protect Borrowers.
A group of congressional Democrats, including U.S. Sen. Tammy Duckworth,
sent a letter to Treasury Secretary and Acting IRS Commissioner Scott
Bessent on Nov. 9 calling the tax reinstatement a “financial disaster
for working-class Americans.”
Illinois will also tax loan forgiveness
In addition to federal taxes, some borrowers will also face a similar
tax hike at the state level. Illinois is one of 20 states whose tax
codes automatically conform to the federal change. This means that
unless Illinois legislators decouple the conforming provision before
taxes are due next year, student loan forgiveness amounts will also be
taxed by the state.
“I would certainly be supportive of (decoupling),” Sen. Mike Halpin,
D-Rock Island, said, although it’s currently not an issue that has
reached the Illinois state legislature.
Lawmakers passed a bill in their fall veto session to decouple the state
and federal tax code as it pertained to certain corporate taxes to head
off a budget shortfall for the upcoming year. But it did not address
student borrowing.
Other challenges facing student loan forgiveness are also expected to
take effect this year:
Student loan forgiveness under Biden’s Saving on Valuable Education, or
SAVE, plan has been blocked for more than a year after some
Republican-led states mounted legal challenges, claiming the program is
illegal. As a result, 7 million borrowers have been stuck in
forbearance, which does not count toward loan forgiveness under
income-driven repayment plans or the public service loan forgiveness
provision.
The SAVE plan is an income-driven repayment plan for federal student
loans created to lower monthly payments, limit interest from ballooning
payments, and accelerate loan forgiveness.
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Students study at the John T. Richardson library in Chicago on
Saturday, Jan. 17, 2026. (Medill Illinois News Bureau photo by Sam
Freeman)
If a proposed settlement agreement between the U.S. Department of
Education and the state of Missouri is approved, the SAVE plan will end
entirely. That would require borrowers to switch to another plan, like
an income-based repayment plan, to qualify for loan forgiveness. This
change shouldn’t result in any loss of loan forgiveness credit.
Income-based repayment currently is the only student loan repayment plan
that remains preserved by the One Big Beautiful Bill. Trump’s bill
removed the partial financial hardship requirement from the income-based
repayment, which makes it easier for borrowers with higher incomes to
enroll.
Income-based repayment is a federal student loan plan that caps monthly
payments at a percentage of the borrower’s discretionary income. It is
intended to benefit borrowers who have a high debt relative to their
income.
The SAVE lawsuit also suspended student loan forgiveness under the
Income-Contingent Repayment, or ICR, plan and Pay As You Earn, or PAYE,
plan. The Department of Education agreed to resume processing student
loans that had reached their 25-year or 20-year eligibility thresholds,
after a lawsuit challenge.
Although loan forgiveness under ICR and PAYE is expected to resume in
February, these plans will be phased out under Trump’s bill by July
2028. As with SAVE, borrowers enrolled in ICR and PAYE will need to
switch to an income-based repayment plan or a new Repayment Assistance
Plan, or RAP, that is supposed to launch later this year.
RAP includes lower payments for some borrowers, an interest subsidy that
will prevent loans from ballooning over time, and a 30-year repayment
term before a borrower can qualify for student loan forgiveness. This
repayment term is longer than current IDR options.
“When people have that much of a continual financial strain, they don’t
build up their savings. They might not ever buy a home. They might not
ever have kids,” Zhang said. “They might not ever achieve these
different kinds of financial milestones.”
RAP also will require higher monthly payments for the lowest-income
borrowers.
Finally, borrowers with federal Parent PLUS loans, who are typically
limited to the ICR plan, also could face changes to their repayment
options.
“Individuals with questions about their loans should call our Student
Loan Helpline, 1-800-455-2456, which can direct struggling student
borrowers to free resources about repayment options and information on
avoiding default,” Illinois Attorney General Kwame Raoul said in a
statement.
Borrowers can also use the Federal Student Aid website’s loan simulator
to calculate monthly payments, evaluate repayment plan eligibility and
choose the repayment plan that best suits their needs.
Sam Freeman is a graduate student in journalism with
Northwestern University’s Medill School of Journalism, Media, Integrated
Marketing Communications, and a fellow in its Medill Illinois News
Bureau working in partnership with Capitol News Illinois.
Capitol News Illinois is
a nonprofit, nonpartisan news service that distributes state
government coverage to hundreds of news outlets statewide. It is
funded primarily by the Illinois Press Foundation and the Robert R.
McCormick Foundation. |
