Written By Travis Hornsby, CFA®, CFP®
Updated on May 13, 2025
The American Rescue Plan from 2021 made student loan forgiveness tax-free until the end of 2025. That change was key to making the student loan cancellation programs put forward by the Biden administration possible at all.
But student loan cancellation failed (for the most part), except for some successes through the Public Service Loan Forgiveness (PSLF) and Income-Driven Repayment (IDR) Waivers. With the second Trump administration, borrowers are facing the threat of a student loan forgiveness tax bomb once again.
We’ll cover who should be concerned about the “tax bomb” associated with student loan forgiveness, and who shouldn’t be.
What is the student loan tax bomb?
A student loan tax bomb is an informal name for what happens when a student loan borrower in the private sector reaches the end of their IDR plan length (usually 20 to 25 years).
Under normal Internal Revenue Service (IRS) rules, any forgiven debt is treated as taxable income unless explicitly excluded by law. A borrower with forgiven debt gets a 1099-C showing the amount forgiven, and to the extent the borrower is solvent (meaning their assets are greater than their debts), that debt gets taxed up to the amount forgiven.
During 2021 to 2025, forgiveness of any kind on student loans was not taxable at the federal level.
But that law is expiring, and the new Republican Congress is unlikely to extend tax-free forgiveness of student loans.
PSLF forgiveness is explicitly tax-free, but forgiveness under IDR repayment plans in the private sector may have “the student loan tax bomb” come back shortly.
Why the tax bomb could be restored by the Republican-controlled Congress
The American Rescue Plan is what made the student loan tax bomb go away until 2025.
And that provision expires at the end of 2025, meaning that the forgiveness taxation rules go back to what they were before 2021.
Republicans know that taxation of student loan forgiveness is a key obstacle to student loan cancellation. With the moves by the Biden administration to cancel debt, Republicans are less likely to agree to making student loan forgiveness tax-free. They're keeping the tax requirement in place as a strategic block to broader debt cancellation efforts.
So it would be likely that student loan forgiveness taxation rules revert to the pre-2021 state, where borrowers would be expected to pay tax on the forgiven amount as if it were a bonus in the year of forgiveness (excepting PSLF borrowers).
Who could be impacted by the student loan tax bomb?
Anyone who expects to have loans forgiven under a non-PSLF IDR forgiveness plan between 2026 and 2029 is most likely to be impacted.
Even if Democrats win the 2028 election, it could take time to undo the tax treatment of student loan forgiveness.
If Republicans hold the Senate in 2028 as expected due to the challenging political map Democrats have, the tax treatment of forgiveness wouldn’t be able to be addressed until 2031 at the earliest, due to the midterm elections (this is assuming only a unified Democratic control of Washington would alter the rules).
Who can breathe easier about the student loan tax bomb?
Besides PSLF borrowers (who don’t have to worry about the student loan tax bomb) borrowers with IDR forgiveness dates in the private sector in the mid-2030s and beyond have much less to worry about.
If tax-free forgiveness ends, there will likely be very ugly headlines with professionals forced to raid their retirement, re-mortgage their home, or re-mortgage their practice just to make a tax payment.
If you have $200,000 of student debt, and that debt grows to $300,000 over 20-25 years of IDR payments, and you owe 40% in federal and state taxes on that debt, you’d have to come up with $120,000 all at once in taxes.
Most Americans don’t have that kind of money they could come up with from cash or brokerage accounts, even those with professional educations.
Most folks have their money in their home, their retirement accounts, and their businesses (if applicable).
That means paying tax bombs on student loan forgiveness will be extremely unpopular for affected borrowers. Congress tends to consider modifying rules that have hugely negative consequences for very important constituencies, such as grad degree holding professionals who disproportionately vote.
So borrowers with mid-2030 forgiveness dates and beyond will have time to find out if political pressure results in a policy change.
If it does not, they’ll have more time to put money in a brokerage account to save up for the tax bomb.
What to do if you need student loan tax bomb planning
First, start investing in a brokerage account if you aren’t already.
A reasonable allocation to stocks makes a ton of sense for a goal that could be 10 to 25 years away.
Most borrowers could save a few hundred dollars a month in a brokerage account and protect themselves from much of the downside risk of owing five or six figures in taxes when they get forgiveness.
That’s because borrowers who invest ahead of time for this potential liability will be able to pay much of it all at once by selling stocks and bonds in their brokerage in the year the tax bomb is due.
If you need help planning for this potential liability, Student Loan Planner would love to help.
Not sure what to do with your student loans?
Take our 11-question quiz to get a personalized recommendation for 2025 on whether you should pursue PSLF, SAVE or another IDR plan, or refinancing (including the one lender we think could give you the best rate).
