Millions of Americans enrolled in income-driven student loan repayment plans could be hit with significant federal tax bills starting in 2026. This follows the expiration of a temporary tax shield at the end of 2025, making cancelled loan balances taxable income once again.
The End of Tax-Free Forgiveness
A crucial federal exemption that protected borrowers from being taxed on forgiven student debt has officially lapsed. This provision was originally introduced under the American Rescue Plan Act of 2021. However, lawmakers failed to extend it beyond its December 2025 expiry date, a move not addressed in subsequent legislative packages.
The change directly impacts those enrolled in Income-Driven Repayment (IDR) plans administered by the US Department of Education. These plans calculate monthly payments as a percentage of a borrower's discretionary income and promise forgiveness of any remaining balance after 20 or 25 years of payments.
Understanding the Financial Impact
The potential tax liability, often called a "tax bomb," could be substantial for borrowers. Higher education expert Mark Kantrowitz highlighted the scale of the issue in a conversation with CNBC. He noted that the average loan balance for borrowers in IDR plans is approximately $57,000.
"For someone in the 22% federal tax bracket, that level of forgiveness could generate a federal tax bill exceeding $12,000," Kantrowitz explained. Even borrowers in the 12% tax bracket could face a bill of around $7,000. Furthermore, state taxes may add to this burden in jurisdictions that also treat forgiven debt as taxable income.
Certified financial planner Ethan Miller warned that many borrowers are now approaching the end of their 20- or 25-year repayment timelines. "Those are the folks who really need to be thinking about how the so-called tax bomb is going to impact them," Miller advised.
Exceptions and Critical Planning Steps
There is an important exception to this new rule. The Public Service Loan Forgiveness (PSLF) program, which cancels loans for eligible government and non-profit workers after 120 qualifying payments, remains exempt from federal taxation.
Additionally, borrowers who became eligible for forgiveness before the tax exemption expired on December 31, 2025, may still avoid federal taxes. Following a settlement with the American Federation of Teachers, Education Department officials clarified this position. Financial advisor Nancy Nierman, speaking to CNBC, stressed that affected borrowers should retain dated confirmation of their eligibility, as this documentation could be crucial.
From 2026 onwards, cancelled student loans will be counted as taxable income. This could push borrowers into higher tax brackets and affect their eligibility for other tax deductions and credits. Certified financial planner Landon Warmund urged proactive planning. "If you know this is going to come, be proactive with the planning," he said.
Planning has become slightly more challenging after the Education Department removed its online IDR forgiveness counter tool, with no current plans to restore it. Despite this, financial advisers recommend that borrowers estimate their forgiveness timelines, start setting aside funds for the potential tax liability, and explore IRS payment plans to manage the future bill.
The issue affects a vast portion of the population, with over 42 million Americans holding student loans and total outstanding balances surpassing $1.6 trillion. The return of the student loan tax bomb presents a new financial hurdle for millions seeking debt relief.
