Student loan borrowers and advocacy groups cheered last week’s agreement between the Department of Education and a national teachers union to resume processing student loan forgiveness across several federal programs. But buried in the agreement’s text is an urgent notice that certain borrowers need to take swift action on their student loans if they want to avoid potentially devastating tax consequences.
The agreement announced on Friday between the department and the American Federation of Teachers is intended to resolve a legal challenge the union filed earlier this year over stalled income-driven repayment plan applications. The union had argued that an IDR processing pause was effectively blocking borrowers from legally authorized student loan forgiveness, as IDR provides a pathway to eventual loan cancellation (typically after 20 or 25 years in repayment) and also is usually a required component of Public Service Loan Forgiveness, as well. The union subsequently broadened its allegations in a filing last month to include the department’s alleged suspension of loan forgiveness under several IDR plans for borrowers who would otherwise qualify.
The agreement, which still must be approved by the court, requires the department to resume processing student loan forgiveness. And it also makes assurances that the department will shield qualifying borrowers from the so-called student loan forgiveness tax bomb set to resume next year if borrowers qualify for relief during 2025, which was a major concern that the AFT raised in its amended lawsuit. But some borrowers enrolled in the SAVE plan will need to take swift action by the end of December to benefit from that the tax protections. Here’s a breakdown.
Student Loan Forgiveness Tax Bomb
Historically, student loan forgiveness under IDR plans was treated as a potential taxable event for borrowers, requiring them to report the cancelled debt on their tax return as “income” for tax purposes. The tax code provides some limited ways of avoiding tax liability associated with cancelled debt, such as if the debtor is insolvent. But for many borrowers, benefiting from a significant one-time cancellation of student loans or other debt can lead to serious tax consequences. Other forms of student loan forgiveness, like PSLF, are not taxed as income at the federal level.
The American Rescue Plan Act of 2021, passed by Democrats in Congress and signed by President Joe Biden, exempted student loan forgiveness under IDR plans from federal taxation. But the relief was temporary, and barring any extension made by Congress, would expire at the end of 2025. Congressional Republicans and President Donald Trump declined to extend this relief in the One Big, Beautiful Bill Act that was enacted this summer. As a result, student loan forgiveness under IDR plans goes back to being taxable again starting at the beginning of next year (loan forgiveness under PSLF remains tax free federally).
The AFT raised the enormous implications of this in its amended lawsuit, arguing that the department’s processing delays and suspension of student loan forgiveness under several IDR plans were putting many borrowers at risk of massive tax consequences that they should not have to face. Borrowers who are entitled to a discharge of their student loans during 2025, the union argued, could face devastating tax liability if their cancellation is pushed into next year.
“Any borrower who is currently eligible to have their loans cancelled under an IDR plan, such as the IBR plan, but whose cancellation is being withheld by the Department, risks this cancellation being taxed as federal income if the cancellation is not processed before January 1, 2026,” said the AFT in a motion for a preliminary injunction filed last month.
Agreement To Apply Student Loan Forgiveness Tax Protections
Under the terms of the agreement announced last Friday between the AFT and the Department of Education, the department will treat the borrower’s eligibility date for IDR student loan forgiveness as the effective date of discharge for purposes of federal taxation. So those who reach the 20- or 25-year threshold for a discharge during 2025, but don’t receive cancellation of their student loans until 2026, should be protected from federal tax liability.
“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,” reads 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.”
Importantly, while the agreement provides tax relief protections to borrowers who qualify for student loan forgiveness now, it is ultimately up to the Internal Revenue Service to determine tax liability. And the agreement acknowledges this.
“Plaintiffs acknowledge that the IRS and the U.S. Department of the Treasury, and not Defendants, have the final say on whether Defendants’ student loan cancellations qualify as taxable income under Section 9675(a) of the American Rescue Plan Act of 2021, previously codified at 26 U.S.C. § 108(f)(5) (2023),” reads the agreement.
Action Required For Some SAVE Plan Borrowers Who Qualify For Student Loan Forgiveness
While borrowers who qualify for student loan forgiveness under the IBR, ICR, and PAYE plans are covered by the tax relief protections of the agreement between the AFT and the Department of Education, SAVE plan borrowers are not, unless they take specific steps within the next 10 weeks.
The SAVE plan has been the subject of a legal challenge since last year, and a federal appeals court blocked the program in August 2024. As a result, millions of SAVE plan borrowers have been stuck in an involuntary forbearance, which isn’t counting toward eventual student loan forgiveness for IDR plans or for PSLF.
Some borrowers in the SAVE plan may have reached their 20- or 25-year eligibility threshold for student loan forgiveness, even as they remain stuck in the forbearance. But under the federal appeals court order, the Department of Education cannot process loan forgiveness for these borrowers unless they switch their student loans to one of the other IDR plans (payments that count toward loan forgiveness under SAVE should also count toward loan forgiveness under the other IDR plans).
Importantly, under the terms of the AFT agreement, SAVE plan borrowers who qualify for student loan forgiveness now must apply to switch to either IBR, ICR, or PAYE before the end of 2025 to benefit from the tax bomb protections outlined in the department’s agreement with the AFT. That gives these borrowers a fairly short window of time (around 10 weeks) to take action.
“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.”
This means that SAVE plan borrowers who qualify for student loan forgiveness now can be protected from federal taxation as long as they apply to switch their student loans to IBR, ICR, or PAYE before the end of this year. Even if they aren’t actually placed in one of those plans (or they don’t receive loan forgiveness) until 2026, under the terms of the agreement, the department indicates that it will not issue a Form 1099-C to these borrowers, which would normally trigger potential tax liability.
Other Reasons Student Loan Borrowers Should Leave SAVE Plan
Protection from student loan forgiveness-related tax liability isn’t the only reason SAVE plan borrowers may want to consider switching to IBR, ICR, or PAYE.
First, SAVE is unlikely to return. The federal appeals court that blocked the program last year indicated that there is a high likelihood that the plan will be struck down when the litigation concludes. Even if that does not happen, the One Big, Beautiful Bill Act will sunset the SAVE plan (along with PAYE and ICR) by July 2028. So one way or another, SAVE does not appear likely to come back.
In addition, the Trump administration resumed interest accrual on student loans for SAVE plan borrowers in August. As a result, borrowers have lost one of the key features and benefits of the forced forbearance. While payments continue to be suspended, SAVE plan borrowers are now seeing their loan balances increase due to interest accrual.
And finally, the time spent in the SAVE plan forbearance continue to not count toward eventual student loan forgiveness. This is true for IDR loan forgiveness as well as PSLF. Borrowers who want their student loans to continue to progress toward eventual loan cancellation, particularly those who are pursuing PSLF, may want to at least consider switching to IBR, ICR, or PAYE. Given SAVE’s likely demise, borrowers will at some point be forced to change repayment plans, and there may be some benefits to doing it under circumstances where the borrower has a bit more control over the process.
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