Student Loan : Crushing Tax Bill Awaits 1 Million Student Loan Borrowers

A Looming Financial Shock: Delayed Student Loan Forgiveness Could Trigger Massive Tax Bills for Borrowers

A major teachers’ union is sounding the alarm, warning that over one million student loan borrowers could be hit with a devastating and unexpected tax bill due to administrative delays within the U.S. Department of Education.

Thank you for reading this post, don't forget to subscribe!

In a recent court filing, the American Federation of Teachers (AFT) stated that borrowers who are legally entitled to have their student loans forgiven but are stuck in a processing backlog may face an “enormous tax liability.” The core of the issue lies in the impending expiration of a critical tax provision and a massive delay in processing applications for key forgiveness programs.

The Perfect Storm: Expiring Tax Relief and Processing Delays

The crisis stems from two converging problems:

1. The End of Tax-Free Forgiveness: The American Rescue Plan Act of 2021 made all student loan forgiveness tax-free at the federal level. However, this beneficial provision is set to expire on January 1, 2026. Unless Congress acts to extend it, any debt canceled after that date will be treated as taxable income by the IRS.

1. A Massive Application Backlog: Despite being eligible, countless borrowers are waiting for the Department of Education to process their applications for Income-Driven Repayment (IDR) plans and the Public Service Loan Forgiveness (PSLF) program. Recent court documents reveal a staggering backlog of over 1.3 million IDR plan applications and 72,730 pending PSLF determinations.

The AFT’s lawsuit, filed in March and now seeking class-action status, alleges that the current administration is denying borrowers access to these critical relief programs. IDR plans cap monthly payments based on income and forgive remaining debt after 20-25 years, while PSLF forgives debt for public servants after 10 years of qualifying payments.

The Staggering Cost of the Tax Bomb

The potential financial impact on individual borrowers is severe. The average loan balance for borrowers in IDR plans is approximately $57,000.

• A borrower in the 22% federal tax bracket could suddenly owe the IRS over $12,000.
• Even those in the 12% bracket would face a bill of around $7,000.

“This isn’t just a bureaucratic delay; it’s a failure that could cost families thousands of dollars they don’t have,” the AFT argued in its filing. This concern is echoed by lawmakers, including Sen. Bernie Sanders (I-Vt.), who recently penned a letter to Education Secretary Linda McMahon urging immediate action to forgive the debt of eligible borrowers before the tax deadline.

It’s important to note that while PSLF forgiveness is never subject to federal tax, borrowers in both IDR and PSLF may still face state tax bills depending on their local laws.

What Borrowers Can Do Now: Steps to Prepare

Financial advisors are urging borrowers to take proactive steps to mitigate this potential financial shock. Nancy Nierman, of the Education Debt Consumer Assistance Program, offers this advice:

• Save Your Records: Meticulously keep all payment records and correspondence with your loan servicer. This documentation could be vital if you need to prove you were eligible for tax-free forgiveness before the 2026 deadline.
• Start Planning Now: If you anticipate receiving forgiveness after January 1, 2026, begin setting aside money now for the potential tax bill. Even small, regular contributions to a savings account can help soften the blow.
• Know Your Options: Remember, if you do get a large tax bill, you are not necessarily required to pay it all at once. You can request an installment plan with the IRS to spread the payments over time. In cases of serious financial hardship, it may even be possible to have the tax bill reduced or eliminated.

The situation remains fluid, and advocates continue to push for a permanent extension of tax-free student loan forgiveness. For now, borrowers are advised to stay informed, keep detailed records, and prepare for a range of outcomes.