The American Rescue Plan recently passed by Congress makes student loan forgiveness tax-free for the next five years. This removes from the student loan forgiveness debate the inconvenient fact that canceled debt is typically treated as income—and is therefore subject to income tax. Our analysis shows that, absent such a provision, forgiveness could have harmed many borrowers in the short run by saddling them with large and unexpected tax bills, even if it would have been a good deal in the long run.

To understand the implications of making forgiveness tax-free, we consider the two most common forgiveness proposals—President Biden’s proposal to forgive up to $10,000 of federal student loan debt per borrower (“the 10K plan”) and Senator Schumer and Warren’s proposal to forgive up to $50,000 (“the 50K plan”). How much would different kinds of borrowers have owed in additional federal taxes under each of these plans?

The answer to this question depends on two key factors: how much debt a household has forgiven and its income. Our progressive tax system means that high-income households will pay more in taxes on the forgiven debt, and a large amount of forgiveness could push a household into a higher tax bracket. Many low-income households do not pay federal income taxes, and some receive refunds such as the earned income tax credit (EITC).

As the figure below shows, borrowers earning at least $122,000, who account for about 20 percent of borrowers, would owe the most additional tax—$2,400 under the 10K plan and $6,160 under the 50K plan. Those earning less than $25,000—about 12 percent of borrowers—would owe $800 and $1,893, respectively.

Under the 10K plan, most households get the full $10,000, so the difference in taxes owed is driven mostly by progressive taxation. Under the 50K plan, higher-income borrowers receive more forgiveness (and thus more additional taxable income) than lower-income borrowers because they hold more debt (median amounts of $25,200 for the highest quintile versus $16,000 for the lowest).

The additional taxes owed could be unduly burdensome for many low-income borrowers. Consider the median borrower in the second income quintile, earning between $25,000 and $43,000 a year. Under the 10K plan, she would face an additional $1,200 in federal income tax burden. Under the 50K plan, this same borrower would owe nearly $4,200 in additional federal income taxes on $25,760 of forgiveness. For perspective, nearly half of borrowers in this income quintile can’t cover the amount owed under the 10K plan from money in their checking and savings accounts.

We also consider the likely burden of the tax cost of loan forgiveness by calculating it as a share of income. For more than three-fifths of borrowers in the lowest income quintile, their additional tax burden under the 10K plan would represent more than 5 percent of their income, and for nearly one-fifth, it would represent more than 10 percent.

For low-income households receiving the EITC, the impact could be especially difficult. Roughly 14 percent of households with student debt pay negative income tax, largely because of the EITC. Many of these households plan their spending around that additional income, but more than 90 percent of them would see that refund shrink, and more than a quarter would owe taxes, rather than receiving a check. This sudden loss of income comes suddenly and without a choice—unlike additional tax liability, which can be optionally spread over time via an installment plan (albeit with interest).

Under the 50K plan, the share of borrowers paying more than 5 or 10 percent of their income in additional taxes goes up to 70 percent and 60 percent, respectively, with borrowers in the second quintile facing even higher burdens than those in the first quintile (likely because many households with very low incomes are not subject to federal income tax).

We do not find large differences in additional tax liability by race. About 15 percent of both Black and white borrowers would owe at least an additional 10 percent of their income under the 10K plan. We do see some differences under the 50K plan: Black borrowers would face the highest additional taxes as a share of income, with more than 60 percent owing at least 5 percent of their income and nearly half owing at least 10 percent (compared with 55 percent and 21 percent of white households). This is because the typical student loan debt among Black borrowers is higher ($29,000) than for white borrowers ($22,500), the result of structural factors such as the racial wealth gap and labor market discrimination.

Our analysis shows the risk of converting education debt into tax debt for many low-income borrowers, especially if the amount of forgiveness is large. The American Rescue Plan ensures any loan forgiveness plan enacted in the near future won’t lead to unexpectedly large tax bills, especially for low-income borrowers. Before this provision expires in 2026, Congress should consider whether to make it permanent for all borrowers or target it in some way, such as by limiting the amount of tax that can be assessed based on the borrower’s income.

Methodology notes: We use the National Bureau of Economic Research’s TAXSIM program and the 2019 Survey of Consumer Finances (reflecting 2018 income data) to estimate the change in federal income tax for each forgiveness scenario. For simplicity, we calculate only federal liability, though households could also owe state taxes. We treat forgiveness as “other income” for tax purposes. For simplicity, all nonforgiveness income is treated as wage income. We use “borrower” as shorthand for “household with student loan debt,” and some households may have two borrowers. The forgiveness plans we simulate provide up to either $10,000 or $50,000 per borrower in the household. We first forgive the debt held by borrowers for their own education, and if they also hold debt for their children’s or other relative’s education, we forgive it up to an assumed household maximum of $20,000 or $100,000.