WASHINGTON DC, UNITED STATES – NOVEMBER 5: Senator Bernie Sanders (I-VT) speaks at an impromptu press conference in Washington DC on November 5, 2025. Sanders and several other Democratic senators recently warned about looming tax consequences associated with student loan forgiveness. (Photo by Nathan Posner/Anadolu via Getty Images)
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Advocates for student loan borrowers and Democratic lawmakers in Congress are sounding the alarm that recent legislative changes made by Republicans could result in substantial financial penalties for those who are pursuing student loan forgiveness.
Last week, Protect Borrowers (a student loan borrower advocacy organization) released a detailed analysis suggesting that, after congressional Republicans declined to extend tax relief for many Americans who are pursuing student loan forgiveness under income-driven repayment plans, borrowers could get slammed with thousands of dollars in unexpected tax liabilities. Senate Democrats followed up the analysis with a letter to Treasury Secretary Scott Bessent, arguing that he has legal authority to use executive action to shield borrowers from tax liability.
“This tax bomb will force working families to trade their crushing student loan debt for a crushing tax debt,” warned Protect Borrowers in a statement on Monday.
Here’s what borrowers need to know about the tax consequences looming over student loan forgiveness.
Student Loan Forgiveness Returns To Being Taxable In 2026
Many forms of debt cancellation can be taxable events. When a lender writes off, discharges, or cancels a debt, they can issue the debtor or borrower a Form 1099-C, which notifies the IRS of the amount of the discharged debt and requires that the borrower report that amount as income on their tax return. The cancelled debt can then be taxed as if the borrower earned the amount in income that year.
Historically, this has also been true for student loan forgiveness. Certain loan forgiveness programs, such as Public Service Loan Forgiveness and Borrower Defense to Repayment, have been exempt from federal taxation. But that hasn’t been the case for loan forgiveness under income-driven repayment (or IDR) plans. The American Rescue Plan Act of 2021 temporarily exempted all forms of student loan forgiveness from federal taxation, but only through the end of 2025. Congressional Republicans did not extend this relief in the One Big, Beautiful Bill Act that they passed this summer; that means that IDR student loan forgiveness returns to being taxable again starting in January.
“In 2021, Congress passed into law a provision excluding student debt cancellation from taxable income,” said Protect Borrowers in its statement on Monday. “As a result, borrowers who received student debt relief after years of repayment were not faced with high and unexpected tax bills. However, that provision is set to expire at the end of this year. Absent action from President Trump or Republicans in Congress, this expiration will mean that borrowers on IDR plans who have legally earned debt cancellation after 20 or 25 years of repayment will be hit with significant tax bills.”
Student loan forgiveness through PSLF and Borrower Defense to Repayment will remain tax exempt federally.
Tax Penalty For IDR Student Loan Forgiveness Could Be In The Tens Of Thousands
The tax consequences that stem from IDR student loan forgiveness could be devastating for low- and middle-income families, warned Protect Borrowers.
“While the OBBBA permanently extended the exclusion of cancelled debts for death and disability, millions of borrowers who are currently on track to earn debt relief under an IDR plan after January 1, 2026, will see a massive increase in their federal income tax liability and therefore have to pay thousands of dollars in additional taxes,” said the group in an analysis published last week. “A married borrower with two dependents, making $40,000 a year, could shoulder a net loss of $10,295 in credits and additional taxes.” This is based on an estimated average of $49,320.51 in cancelled debt under IDR, according to Department of Education data.
“Lower-income borrowers’ effective tax rates would likely increase the most, prior to the application of remaining eligible tax credits,” continued Protect Borrowers. “Borrowers who earn the median income of a bachelor’s degree holder ($80,236) would see their effective tax rates double, but a married borrower with two dependents who makes $40,000 a year would see their effective tax rate grow over nine times.”
Higher-income earners with advanced degrees who have significant student loans could see even more significant tax liability associated with IDR student loan forgiveness. These borrowers not only have higher incomes (and therefore would be subject to higher taxes), but they also tend to have larger balances when they reach the threshold for IDR student loan forgiveness.
“A single borrower earning $80,236 could pay an additional $2,657 in taxes on average for every $10,000 in additional debt cancellation earned,” said Protect Borrowers.
The group provided an example of a borrower who “finished a master’s degree in 1994 and had an initial loan balance of $55,000,” but saw their balance balloon to $260,000 due to negative amortization, the process by which a borrower’s student loan balance increases over time while in an IDR plan due to the ongoing accrual and capitalization of interest. Negative amortization is a fairly common phenomenon for borrowers in IDR plans.
“If his $260,000 balance is cancelled and treated as income, he could be forced to pay an additional $73,691 in taxes (increasing from $8,551 to $82,242),” said Protect Borrowers. “His effective tax rate could increase over nine times, from 10.66 percent to 102.50 percent (more than his total real annual income).”
Lawmakers Call For Tax Exemptions For Student Loan Forgiveness
Dovetailing on Protect Borrowers’ analysis, nearly a dozen Democratic senators, including Senators Bernie Sanders (D-VT) and Elizabeth Warren (D-MA), wrote to Treasury Secretary Scott Bessent last week, urging him to use executive authority to protect borrowers from the tax consequences associated with student loan forgiveness.
“If neither the Trump Administration nor the Republican-controlled Congress act soon, families who earn student debt cancellation after paying their loans for decades will be hit with surprise tax hikes,” warned the lawmakers. “Using administrative authorities available under federal law, the Treasury Department and Internal Revenue Service (IRS) should move immediately to avoid this financial disaster for working-class Americans.”
The senators suggested three possible unilateral actions that Bessent could take:
- Utilize the insolvency exemption to create a safe harbor for student loan borrowers. Individual taxpayers can be exempted from taxation tied to debt cancellation if they can demonstrate that the value of their debts exceeds the value of their assets. But the process of utilizing this exemption can be cumbersome. The senators suggested that the Department of Treasury can essentially create a blanket presumption of insolvency for borrowers who receive student loan forgiveness under IDR, shielding them all from tax liability.
- Apply the “qualified scholarship exclusion” to IDR student loan forgiveness. The rule excludes from gross income “any amount received for a scholarship used for ‘qualified tuition and related expenses,’ including ‘tuition and fees’ and ‘fees, books, supplies, and equipment required for courses of instruction.’”
- Apply the “general welfare exclusion” to IDR student loan forgiveness. To qualify, “payments must (i) be made from a governmental fund, (ii) be for the promotion of the general welfare (i.e., generally based on individual or family needs), and (iii) not represent compensation for services.” The senators argued that IDR student loan forgiveness “meets each of these three requirements.”
“By punishing IDR beneficiaries with massive tax bills, the federal government undermines the very purpose of the IDR program and reneges on its promises to borrowers,” wrote the senators. “Instead of compounding this problem by denying legally owed IDR discharge to borrowers, the Administration can and should deliver certainty and relief to these families as soon as possible.”
Narrow Student Loan Forgiveness Tax Exemption Under Settlement Agreement
In a recent settlement agreement announced in October to resolve a legal challenge over delayed or blocked IDR student loan forgiveness, the Department of Education agreed to extend tax relief for certain borrowers who are entitled to a discharge under IDR but experience delays. Specifically, the department committed to not issuing a Form 1099-C to borrowers who reach their 20- or 25-year milestone for IDR student loan forgiveness before the end of 2025, but are delayed in receiving a discharge of their student loans until 2026.
But this narrow exception will only apply to borrowers whose student loans reach their IDR cancellation milestone by December 31, 2025. All other borrowers who become eligible for IDR student loan forgiveness in 2026 or later could face enormous tax liability, barring further action by Congress or the Trump administration. So far, neither has given an indication that any action is imminent.
