Student loan borrowers scored a major victory on Friday as the Department of Education agreed to resolve a legal challenge by resuming student loan forgiveness that had been halted for millions. The department also agreed to take steps to shield borrowers from looming tax liability associated with having their student loans discharged. The Trump administration and the American Federation of Teachers, a national teachers union, announced the joint agreement in a court filing on Friday.
“This is a tremendous win for borrowers,” said Winston Berkman-Breen, Legal Director for Protect Borrowers which has been representing the AFT in its lawsuit against the department. “With today’s filing, borrowers can rest a little easier knowing that they won’t be unjustly hit with a tax bill once their student loans are finally cancelled, pursuant to federal law. The U.S. Department of Education has agreed to follow the law and deliver Congressionally mandated affordable payments and debt relief to hard-working public service workers across the country, and will do so under court supervision.”
Here’s what the latest development means for student loan forgiveness, and what borrowers should expect in the coming weeks and months.
Lawsuit Challenged Blocked Student Loan Forgiveness And Looming Tax Liability
The unexpected agreement between the AFT and the Trump administration resolves a legal challenge that the union filed against the department earlier this spring, originally over massive delays associated with IDR applications. The AFT had argued that these delays were preventing borrowers from accessing congressionally-mandated student loan forgiveness under income-driven repayment plans and Public Service Loan Forgiveness, or PSLF.
Last month, the union amended its complaint to encompass additional allegations. The AFT argued that the Department of Education was illegally blocking student loan forgiveness under multiple IDR plans including ICR, PAYE, and IBR. The AFT argued that loan forgiveness was only legally blocked for borrowers enrolled in the SAVE plan, which has been subject to a court injunction since last year following a separate legal challenge brought by Republican-led states. The AFT also contended in its amended suit that the department was improperly rejecting IDR applications; dragging its feet in expanding access to the IBR plan following changes to the program made under the One, Big Beautiful Bill Act; and failing to adequately process applications for student loan forgiveness under the PSLF Buyback program, which allows borrowers to make a lump sum payment so that disqualified periods of deferment or forbearance can count toward eventual student loan forgiveness.
The AFT filed an emergency motion requesting immediate intervention by the court because of a looming tax liability cliff. Under the American Rescue Plan Act of 2021, student loan forgiveness under all IDR plans has been tax free for the last four years. But that relief is set to end on December 31, as Congress declined to extend that relief beyond this year. The AFT argued that this would lead to catastrophic tax consequences for borrowers who qualify for student loan forgiveness now, but don’t receive it until next year or beyond because of the department’s ongoing processing pauses and delays.
Department Of Education Agrees To Resume Student Loan Forgiveness Processing
Under the terms of the agreement announced on Friday, the Department of Education will resume processing student loan forgiveness not only under the IBR plan, but also the ICR and PAYE plans, as well. The department had maintained that student loan forgiveness was not allowable under ICR and PAYE following a court ruling in the SAVE plan litigation earlier this year, but the AFT had disputed this. All parties had agreed that loan forgiveness under IBR was legal, but the department had contended that it had to pause IBR loan forgiveness in order to update its internal systems to comply with the recent court rulings.
Under the terms of the agreement with the AFT, the department “will continue processing loan cancellations for borrowers who are eligible for cancellation under the Income-Based Repayment (IBR) plan.” Processing for IBR loan forgiveness appeared to resume in September, when mass emails were received by borrowers notifying them that they qualify for a discharge.
In a significant additional provision of the agreement, the department agreed that it will “continue processing loan cancellations for borrowers who are eligible for cancellation under the Original Income Contingent Repayment (ICR) and Pay As You Earn (PAYE) plans as long as these plans are in effect.” Under the terms of the “One Big, Beautiful Bill Act,” ICR and PAYE will continue to exist until they are sunsetted in July 2028. Until now, the department had advised borrowers who qualify for student loan forgiveness under ICR and PAYE that they would need to switch to the IBR plan to receive a discharge.
The department also agreed to “continue processing applications for Public Service Loan Forgiveness (PSLF) Buybacks,” although the program continue to suffer from significant backlogs and delays.
Borrowers Receiving Student Loan Forgiveness To Be Shielded From Tax Liability
In another major development, the department agreed to shield borrowers who qualify for student loan forgiveness now from tax liability, even if their discharges are delayed beyond the end of this year.
“Defendants agree that for their internal purposes, the date a borrower becomes eligible to have their loans cancelled under the IBR, Original ICR, or PAYE plans constitutes the effective date of their loan discharge,” says the agreement. “Defendants agree to not file an Internal Revenue Service (IRS) Form 1099- C for a borrower who becomes eligible for discharge in 2025 if the conditions in IRS Notice 2022-1 are met.” A Form 1099-C is the tax form that typically would be issued to borrowers that would require them to report the amount of cancelled debt as “income” for tax purposes, leading to potentially devastating tax consequences.
The department further clarified that this tax protection will shield borrowers who qualify for student loan forgiveness under the SAVE plan, but switch to either IBR, ICR or PAYE before the end of the year. Loan forgiveness under SAVE remains blocked due to a separate injunction by the Eighth Circuit Court of Appeals.
“For avoidance of doubt, Defendants agree that for their internal purposes, when a borrower (1) has achieved eligibility under the Saving on a Valuable Education (SAVE) plan, (2) applies to transfer to one of the IBR, Original ICR, or PAYE plans on or before December 31, 2025, and (3) that application is approved on or after January 1, 2026—the date that borrower becomes eligible for cancellation under the new plan constitutes the effective date of their loan discharge, even if that date falls on or before the date the borrower’s application was approved.”
Importantly, under the terms of this provision, SAVE plan borrowers who have reached their student loan forgiveness eligibility threshold must apply to switch to IBR, ICR or PAYE on or before December 31, 2025.
The department also promised that borrowers who have made payments beyond the requisite amount required to receive student loan forgiveness will “be reimbursed for any payments made on the loan after the final payment that qualified them for discharge.”
“By agreeing to the foregoing, Defendants do not stipulate to or concede any factual or legal allegations that have been raised or could have been raised in this proceeding, including but not limited to any findings the Court would be required to make before granting injunctive relief,” said the department.
Court Will Monitor Compliance With Student Loan Forgiveness Processing
While the agreement announced on Friday will resolve the immediate issues associated with the AFT’s legal challenge, it does not formally end the lawsuit. The department agreed to file monthly status reports detailing its progress in implementing the agreement so that the AFT, the court, and the public at large can monitor the department’s compliance.
“Defendants will file six status reports that provide public information about certain topics raised in this litigation,” says the agreement. “Defendants’ first status report shall be due 30 days after the current lapse in federal government appropriations ends, and subsequent status reports will be due every 30 days thereafter.”
“We fully intend to hold them to their word,” said Berkman-Breen, indicating that the AFT would closely monitor the department’s progress in implementing student loan forgiveness under IBR, ICR, PAYE, and PSLF over the course of the next six months.
Read the full article here
