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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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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