Federal policy shift may cause student loan borrowers to face state and federal taxes on forgiven debt

Student loan borrowers in Illinois could face federal, state ‘tax bomb’ in 2026. Illinois is among 20 states whose tax codes automatically follow federal changes, potentially taxing forgiven student loans at the state level. Borrowers should review repayment options and seek guidance.

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Image: 3D Animation Production Company/Pixabay

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by Sam Freeman & Medill Illinois News Bureau
Capitol News Illinois

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.

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.

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TAGS: student loan forgiveness taxable Illinois, federal student loan tax policy changes, income-driven repayment forgiveness taxes, Illinois student loan tax conformity, student loan forgiveness 2026 taxes

Commentary |Trump wants to cut taxes for the rich, states can choose differently

by Eli Taylor Goss & Treasure Mackey

      OtherWords

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As President Trump takes office, one of his first agenda items is to slash taxes on corporations and the rich. The results will be more inequality and less revenue for the programs Americans rely on.

The good news? States can make their own tax codes more equitable. And everyday people can help.

With the help of public opinion, strategic communications, and messaging research firms, we spent over a decade talking to people in Washington to better understand their deeply held beliefs about taxes.

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In our state, Washington, people voted overwhelmingly this past November to protect our state capital gains tax on the ultra-wealthy. This was a hard-fought victory by a movement of people who believe we need a better tax code.

Let’s back up.

Despite our “blue state” status, Washington’s tax code has long been one of the most inequitable in the country because it over-relies on regressive measures like sales taxes and property taxes. That forces low- and middle-income earners to pay the biggest portion of their income in taxes to fund the programs and services we all rely on.

In 2010, an initiative to enact a tax on high earners in our state failed miserably. Although many people — including lawmakers — proclaimed the death of progressive taxes in Washington, advocates came together with a long-term goal of building public support for progressive revenue.

Our organizations were two of many that did this work. From interfaith organizations to affordable housing advocates to union leaders, we created coalitions to hold lawmakers accountable to build an equitable tax system.

In addition to organizing and legislative strategies, our coalitions prioritized shifting the public narrative.

With the help of public opinion, strategic communications, and messaging research firms, we spent over a decade talking to people in Washington to better understand their deeply held beliefs about taxes.

We learned that most Washingtonians felt the impacts of our upside-down tax code but didn’t realize just how much it favored the rich. And in focus groups and community meetings, we heard people vocally support taxes when they understood the services they provide.

Our state capital gains tax is an excise tax on the sale of high-end stocks and bonds. Many extremely wealthy people are able to hoard wealth from selling these stocks.

In media interviews, legislative testimonies, community events, and town halls, we showed how creating a budget that funds our communities requires the wealthy to pay what they owe. We tied taxes to critical programs and services like child care, education, parks, and safety net programs.

We also highlighted how our tax code — which was designed to favor white, land-owning men over everyone else — is harmful to communities of color and low-income people.

Buoyed by grassroots organizing and legislative efforts, national momentum for taxing the rich, and some wealthy spokespeople who said “we want to pay this,” our coalitions helped our legislature pass a capital gains tax in 2021. We also helped pass a Working Families Tax Credit that year, a cash boost for people with low incomes. Together, these policies started to holistically fix our tax code.

Our state capital gains tax is an excise tax on the sale of high-end stocks and bonds. Many extremely wealthy people are able to hoard wealth from selling these stocks.

In its first two years, our modest capital gains tax on the richest 0.2 percent of Washingtonians brought in $1.3 billion to increase access to affordable child care and support school construction projects. But as soon as it passed, a handful of uber-wealthy individuals filed a lawsuit to repeal the tax.

Ultimately, the state Supreme Court upheld it. The last test was on the ballot in November. We soundly defeated Initiative 2109, a last-ditch effort to repeal the tax. Over 64 percent of voters — including majorities in right-leaning counties — supported keeping the capital gains tax in place to fund schools and child care.

Our win — which many thought impossible a decade ago — was a bright spot nationally this fall. We still have a long way to go towards a just tax code, but it’s possible to flip the script and build public support for progressive revenue. Wherever you live, we hope your community is the next to make that happen.

Eli Taylor Goss is the executive director of the Washington State Budget and Policy Center, a research and policy organization that works to advance economic justice. Treasure Mackey is the executive director of Invest in Washington Now, an organization working to remake our tax code so it works for everyone. This op-ed was distributed by OtherWords.org.

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'Temporary' tax increases always become permanent in Illinois

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Ben Szalinski
Illinois Policy

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State politicians have repeatedly reduced backlash from tax hikes by calling them temporary. That’s what they did in 1989 and 2011 but voted later to break their promises and make the increases permanent.

In 1989, former Republican Gov. Jim Thompson was pushing for a permanent 40% tax increase. Thompson lacked support from Democrats and reached a compromise with Speaker of the House Michael Madigan to temporarily raise taxes by 18% for the next two years by raising the rate from 2.5% to 3%.

At the time, Madigan said Illinois did not need more tax revenue. Thompson disagreed, saying it was necessary to address concerns over school funding and property taxes. He said a temporary hike just pushed the problems to the future.

Two years later, lawmakers again voted to extend the temporary increase. In 1993, the General Assembly made it permanent.

Following the Great Recession in 2011, former Gov. Pat Quinn and state lawmakers jacked taxes up from 3% to 5%, again with the promise it would be temporary. Quinn said the increase was to help the state pay the bills and regain sound financial footing. Former Senate President John Cullerton promised it would help pay for pensions without borrowing.

“The point of this income tax increase is not to expand programs, not to do brand new things in Illinois state government, it is only intended to pay our old bills and deal with the structural deficit,” said former House Majority Leader Barbara Flynn Currie.

Lawmakers planned to partially sunset the tax to 3.75% in 2014 and 3.25% in 2025. The decrease did happen in 2014, but it was short lived.

The General Assembly passed the largest tax increase in Illinois history in 2017 by raising rates back up to 4.95%.

The temporary 2011 hike solved few problems for Illinois and the 2017 increase has been no better. The state still struggles with the nation’s worst pension crisis and the deficit has quadrupled since 2011.

Illinois' net position worsens dramatically despite two major tax hikes

Gov. J.B. Pritzker is now asking taxpayers to play this game again with a progressive income tax structure. He wants a small percentage of Illinois taxpayers to pay more in taxes to bail out the state’s financial mismanagement.

However, the governor’s revenue projection falls short. Pritzker says a progressive income tax will net the state an additional $3.4 billion. Analysis by the Illinois Policy Institute found it would only generate $1.4 billion more.

There is no possible way Pritzker can fulfill all of his spending promises, pay down billions in debt and still cut taxes for 97% of Illinoisans, as his proposal claims. Eventually, lawmakers will be back seeking another tax increase but with greater power to put unfair burdens on smaller groups of taxpayers, including taxing retirement income like every state with a progressive tax.

The Illinois Constitution contains a flat tax protection, meaning you pay more when you make more and pay less when you make less – but everyone pays the same rate. Lawmakers pay a political price when they raise everyone’s taxes, as happened in 2017 when resignations and voter backlash cleared out the General Assembly.

Giving the General Assembly a progressive income tax would be equivalent to handing them a blank check. They will be able to spend however much they want and selectively target different segments of the population for more taxes, reducing the number of angry taxpayers at any one time.

Illinois voters for the first time in 50 years have a chance Nov. 3 to tell Springfield what they think about tax increases. Lawmakers need to fix basics, such as pension growth and 20 years of deficit spending, before making another promise to taxpayers that history shows is bound to be broken.

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Originally published by Illinois Policy on September 16, 2020. Published by permission.

Small business and retirees could suffer under progressive tax plan

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Ben Szalinski and Adam Schuster
Illinois Policy

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Illinois state Treasurer Michael Frerichs confirmed what many believe would be a new possibility in Illinois if voters pass the progressive income tax amendment: taxing retirees.

"One thing a progressive tax would do is make clear you can have graduated rates when you are taxing retirement income," he said while speaking at an event hosted by the Des Plaines Chamber of Commerce. "And, I think that’s something that’s worth discussion."

According to the Daily Herald, Frerichs said he knows people who receive annual pensions over $100,000 but pay no state income taxes. He said under the flat tax there is no way to differentiate between retirees who take home hundreds of thousands from those who get little.

Illinois voters on Nov. 3 will decide whether to remove the Illinois Constitution’s flat tax protections and give state lawmakers greater power to set tax rates.

All 32 states with a progressive income tax impose some sort of tax on retirement income from 401(k)s, IRAs, Social Security and pension benefits. Mississippi limits its retirement taxes to the income of those who retire before age 59.5.

The constitution’s drafters in 1970 included a flat tax guarantee in order to ease voters’ fears that the state’s first income tax – which went into effect in 1969 – could be raised easily in Springfield. Flat taxes treat everyone the same and make it harder for lawmakers to raise rates on everyone because voters can hold them responsible. A graduated tax allows politicians to decide who should be taxed how much and allows them to gradually increase taxes on smaller segments of the population, eventually hitting the middle class where most taxable income resides.

That is what happened in Connecticut, the only state in the past 30 years to impose a progressive tax. Middle class taxes rose 13%, property taxes spiked 35%, poverty increased by 50%, more than 360,000 jobs were lost and the state economy took a $10 billion hit. All that, and the state still failed to balance its budget.

Gov. J.B. Pritzker has billed a progressive income tax as a way to increase taxes on the rich without also increasing taxes on the poor and middle class. But for a low-income resident making $12,400 a year, the tax would save them $6 while they are still taxed $1,800 a year.

The bigger problem is the tax’s impact on small businesses, which are just starting the economic recovery from Pritzker’s COVID-19 lockdown orders. A progressive tax would mean up to a 47% tax increase on over 100,000 small businesses, the state’s most prolific jobs creators.

Taxing retirement is not a new idea in Illinois. Former Chicago Mayor Rahm Emanuel proposed taxing retirees with incomes over $100,000 last year, while the Civic Committee of the Commercial Club of Chicago proposed taxing retirement income over $15,000 per year.

The Chicago Sun-Times editorial board even tied the two together, writing "Pritzker’s progressive income tax plan can set the stage for far greater tax fairness. Next, that tax should be expanded to include the highest retirement incomes."

Former Democratic gubernatorial candidate and former state Sen. Daniel Biss also agreed with Frerichs’ position that a progressive tax is needed in order for Illinois to tax retirement income.

While government leaders argue for more taxation, Illinoisans want to move in the opposite direction. A 2019 poll by the Paul Simon Public Policy Institute found 73% are against taxing retirement incomes, while just 23% believe it is a good idea. Illinois is one of three states that does not tax retirement income.

With no retirement tax, Illinois can more easily retain retired workers without losing them to more tax-friendly states. Since 2013, Illinoisans over age 65 have been the least likely to move out.

Illinois' tax exemption for retirement helps retain state's older residents

Connecticut’s progressive income tax hits single filers on $50,000 and joint filers on $60,000 of retirement income. Unsurprisingly, Connecticut loses retired residents at a faster rate than Illinois.

If the Land of Lincoln changes tax structures and imposes a progressive income tax that taxes retired workers on their income, these trends can easily change. More Illinoisans over 65 will pack and move to states with better climates and lower tax rates.

Illinois leaders who want to ensure fairness and economic recovery should protect the current tax structure. Progressive taxation and taxing retirement income will not fix the state’s spending problem, but will send more jobs and retirees to other states.

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Originally published by Illinois Policy on June 24, 2020. Published by permission.

Pritzker says state has reached a "critical juncture"

On Tuesday, Illinois Governor J. B. Pritzker ordered state agencies to identify areas of their 2020 budgets that can be cut by 5% as well as 10% cuts that can be made in their spending plans for the next fiscal year should Congress fail to provide additional COVID-19 relief funds.

"Any cut to the Illinois state budget is a win for taxpayers," said Jim Tobin, President of Taxpayers United of America (TUA). "However, a broad cut to the state budget is not enough."

Tobin says the state of Illinois’s financial woes are due to the vast amount it spends on lavish, overpromised retired government employee pensions.

"This is why Pritzker is really cutting the budget, he wants to divert pay from current Illinois government employees to retired Illinois government employees," Tobin said in a release this morning. "Every year former Illinois government employees eat up even more of the state’s budget.

In fact, the primary motivation for a $5 billion state income tax hike that passed a few years ago was to transfer wealth from taxpayers to the black hole that is the Illinois pension funds."

Pritzker calls the current state's budget woes a "nightmare scenario".

We've reached a critical juncture for our own state finances in this COVID induced financial crisis," he said during his press conference in Chicago.

In June, Pritzker signed off on $43 billion dollar budget that began July 1 relied heavily on federal aid and borrowing to fill revenue shortfalls due to the COVID-19-induced economic slowdown.

A memo from Deputy Gov. Dan Hynes and budget director Alexis Sturm to agency directors stated the state's current budget "is only affordable in its current form with federal support to bridge the pandemic-related shortfalls and that now appears not to be forthcoming."

Illinois stands to lose out on $6.5 billion in revenue this year and next year. Agency heads were given until Oct. 2 to outline their reductions for the current year.  This includes taking necessary measures from hiring freezes to renegotiating on any planned spending commitments.

Tobin points out that governor's Illinois progressive income tax is purely a move to raise taxes.

"Pritzker’s income tax increase amendment, better described as an income theft amendment, is not what Illinois needs," he wrote. "Illinois taxpayers should vote no on November 3rd to the proposed amendment change, and demand Pritzker to cut spending further."

Governor Pritzker pushes state income tax filing date to July 15

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Ben Szalinski, Illinois Policy

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Gov. J.B. Pritzker announced at his daily press conference on March 25 that July 15 will be the new deadline for Illinoisans to file state income taxes. The change comes five days after the same move was made by the federal government, which also pushed the deadline to July 15.

Pritzker said refunds are still being processed and distributed for those who have already filed taxes. Additionally, the state is allowing restaurants and bars extra time to pay their sales taxes. Other things such as evictions and utility shutoffs for late payments have also been suspended by executive order.

Pritzker said delaying the filing deadline will help soften the immediate economic impact of the COVID-19 pandemic. The governor instituted a stay-at-home order that started March 21 that will last at least through April 7. All non-essential employees are to stay home and non-essential travel should be limited. On March 16, all restaurants and bars were closed to dine-in customers, but allowed to remain open for drive-through and take-out service.

The closure of businesses is leading to severe economic losses and a rise in unemployment. Between March 16 and 18, unemployment claims in Illinois rose by 64,000. After new social distancing measures were introduced, the number was expected to rise higher. Nationally, some experts believe unemployment may hit an unprecedented 30% in the second quarter.

While the numbers paint a grim economic future, it is important to note many of those seeking unemployment will be able to return to their jobs when social distancing orders are lifted. The current unemployment count does include furloughed workers.

In addition to putting off the day Illinoisans must pay taxes, Chicago Mayor Lori Lightfoot is suspending collection of traffic fees until April 30 to ease the economic burden on residents. Drivers will not immediately have to pay for late parking tickets, towing fees or red-light camera tickets. The city will also suspend its “booting” system.

Illinois currently has 1,865 cases of coronavirus with 19 deaths. The number of cases rose by 330 on March 25, the same day Pritzker announced the delayed tax deadline. Thirty-five counties have reported cases across all ages.

The economic impact of the virus is expected to be staggering in Illinois. The Illinois Policy Institute put together a report detailing what the state must do now to prepare for the fallout from the halt in economic activity, including a commercial property tax holiday and pension reform to preserve needed revenues.

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Originally published by Illinois Policy on March 25, 2020. Published by permission.