A Biden-era tax exclusion for certain student loan discharges is set to expire at year-end, causing discharged balances to be treated as taxable income. A group of Senate Democrats has urged the IRS to take immediate action, contending it has three viable pathways for administrative relief under existing law.
In a November 9 letter to Treasury Secretary and acting IRS Commissioner Scott Bessent, nine Senate Democrats warn that borrowers who use income-driven-repayment (IDR) plans and for whom remaining debt is discharged after a set term could see steep tax hikes beginning in 2026. The letter, headed up by Senator Elizabeth Warren (D-MA), calls on the IRS to prevent this “tax bomb” through existing legal mechanisms.
Taxation of Student Loan Debt Discharges
Taxation of student loan discharges is set forth in IRC § 108(f). Generally, if a taxpayer is responsible for making loan payments, and the loan is canceled or repaid by someone else, the taxpayer must include the amount that was canceled or paid in their gross income for tax purposes. However, the American Rescue Plan Act (ARPA) revised §108(f)(5) to provide that the amount of certain student loans discharged in 2021–2025 is not included in a taxpayer’s gross income.
Specifically, this tax relief applied for certain loans “expressly for postsecondary educational expenses,” “private education loans,” certain loans made by tax-exempt educational organizations, and loans made by other exempt organizations to refinance loans. Consequentially, borrowers whose loans are discharged under IDR plans during this period do not have to include the discharged amount in their gross income. In addition, lenders are not required to issue Form 1099-C for these discharges.
OBBB Changes
With these ARPA provisions set to expire at year-end, the One Big Beautiful Bill Act (OBBB) took steps to mitigate impacts for some taxpayers, but overall, narrowed student loan discharge exclusions. The main exclusions going forward are for discharges due to death, total and permanent disability, certain public service or health professional programs, or specific Department of Education processes (such as Closed School or Defense to Repayment discharges).
After January 1, 2026, other discharged student loan debt — including amounts discharged under IDR plans — will generally be treated as cancellation of debt income and included in the taxpayer’s gross income for federal tax purposes, unless another exclusion applies.
Financial Impact on Borrowers
The senators contend in their letter that, without action from the Trump administration or Congress, borrowers who have made payments for 20 to 25 years to earn debt cancellation under IDR plans will have their discharged balances treated as taxable income. They warn this will create a “financial disaster for working-class Americans.”
The lawmakers say that many of these borrowers have few assets to cover such a tax bill, citing Consumer Financial Protection Bureau data showing 62% of IDR cancellation recipients have household incomes of $50,000 or less.
According to an analysis by Protect Borrowers, the tax implications could be severe. A single borrower making $50,000 could pay an additional $9,178 in taxes, says Protect Borrowers. And lower-income borrowers, particularly those with children, could lose out on credits such as the Earned Income Tax Credit and Child Tax Credit.
The lawmakers note that many of these borrowers have few assets to cover such a tax bill, again, citing Consumer Financial Protection Bureau data.
Administrative Solutions
Treasury and IRS have existing legal authority to prevent this outcome, argue the lawmakers. They offer three potential paths for administrative relief:
Insolvency exclusion. Under IRC § 108, a taxpayer’s gross income does not include debt discharged when they are insolvent, the lawmakers explain. They assert that many IDR recipients are likely insolvent at the time of discharge – and proving insolvency individually is a complex and burdensome process for both taxpayers and the IRS. Therefore, the IRS should issue a blanket safe harbor, say the lawmakers.
Scholarship exclusion. Another existing option for relief is for the IRS to deem IDR discharges “qualified scholarship relief” under IRC § 117. The lawmakers delve into the history of §117 and shifting standards of what constitutes qualified scholarship relief, based on the grantor-grantee relationship. They conclude the §117 pathway is available for IDR recipients under multiple possible standards because there is no “quid pro quo” service agreement or employer-employee relationship.
General welfare exclusion. The senators also suggest the IDR discharges qualify for the “general welfare exclusion.” They point to Rev Rul 2005-46, which provides that the exclusion is available where payments are “made from a governmental fund,” “for the promotion of the general welfare (i.e., generally based on individual or family needs),” and are not “compensation for services.” IDR discharges fit these criteria, the lawmakers conclude.
The senators also note that the Trump administration has previously used administrative discretion to aid taxpayers whose student loans were discharged. Specifically, in Rev Proc 2020-11 the IRS provided safe-harbor relief for borrowers whose loans were discharged through the Closed School or Defense to Repayment programs.
In that guidance, the IRS stated that determining on an individual basis whether affected borrowers are eligible for an exclusion “would impose a compliance burden on taxpayers, as well as an administrative burden on the IRS, that is excessive in relation to the amount of taxable income that would result.” The same logic applies to IDR discharge recipients, the senators argue.
For more information on the tax consequences of student debt discharges, see Checkpoint’s Federal Tax Coordinator 2d ¶ J-7506.
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