A $10K ‘tax bomb’ on forgiven student loans starts ticking New Year's Day, threatening borrowers with a new debt burden

A ‘tax bomb’ is set to detonate on New Year’s Day. The blast could throw the finances of millions of student loan borrowers off balance.

The impending blast is heading for borrowers paying down their student debt through an income-driven repayment (IDR) plan and who seek debt forgiveness on or after Jan. 1, 2026.

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As CNBC reports, the shockwaves could be enormous, adding up to thousands of dollars in unexpected taxes on forgiven loans (1) and hitting the very borrowers the IDR plan was meant to help, who tend to be lower-income.

According to the nonprofit group Protect Borrowers, those seeking forgiveness on the average $49,321 in student debt under the IDR plan in 2026 could see a loss of anywhere from $5,800 to $10,000 in owed taxes and lost credits (2).

Senator Elizabeth Warren, a member of the Senate Finance Committee, joined eight other senators in writing a letter to Treasury Secretary Scott Bessent asking him to prevent this (3).

“Families who earn student debt cancellation after paying their loans for decades will be hit with surprise tax hikes — as high as $10,000 in many cases — starting next tax year,” they wrote, describing the situation as a “financial disaster for working-class Americans.”

Here’s a look at what’s behind the ticking tax bomb and how to prevent it from wreaking havoc on your own financial plans.

Tax bomb effects on household budgets

As it stands, borrowers who make regular payments on student loans under the income-driven repayment (IDR) plan for 20 or 25 years can have their remaining loan balance forgiven, if eligible (4).

As New America reports, the American Rescue Plan Act (ARPA) of 2021 eliminated taxes on forgiven IDR student loans (5).

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Unfortunately, that provision is expiring at the end of 2025, triggering the potential “tax bomb.”

With a median $600 in savings, most households — especially those dealing with significant amounts of student loan debt — could not cover an unexpected tax bill, especially in the thousands of dollars.

In fact, 37% of Americans couldn’t cover a $400 emergency expense, according to an Empower survey. (6).

If the money isn’t available, the likely course of action is to set up a payment plan with the IRS to pay down the newfound tax debt, but that means accruing interest and penalty charges until the debt is paid in full (7).

That means payments to the IRS could end up costing more than IDR plan payments.

Borrowers who don’t have the assets necessary to cover the tax debt might qualify for an insolvency exclusion through the IRS. In this case, the forgiven debt might be excluded from taxable income if the taxpayer’s total liabilities exceed their total assets (8).

But that’s a case-by-case situation. Most borrowers on the IDR plan must prepare for the possibility of significant tax bills when their federal student loan balance is forgiven. Read on to find out to do that.

How to prepare for this change

If you’re on the IDR student loan plan and would qualify for forgiveness in 2026, it’s a good idea to figure out how much you might owe in taxes on the forgiven amount.

Since this varies based on your income, loan balance and more, you’ll need to dig into those details to get a good idea of what you might owe.

Some might be pleasantly surprised by an expected tax bill of much less than $10,000. But if you expect you’d owe several thousand dollars, start making a plan on how you’ll deal with it.

One option is to pursue the insolvency clause through the IRS, which would leave the forgiven debt out of your taxable income.

Another option is to set up a payment plan with the IRS, coming to the table with a clear look at your finances and why you’ll need a payment plan.

Of course, the best outcome is that you’d be able to cover the tax bill without lingering debts.

If you start saving for this potential tax bomb now, you’ll be better prepared.

In addition to setting aside part of your income, consider growing your income through a temporary part-time job or side hustle to help you prepare to cover this tax bill without debt.

Article sources

We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.

CNBC (1); Protect Borrowers (2); Senator Elizabeth Warren (3); Federal Student Aid (4); New America (5); Empower (6); IRS (7, 8)

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.