The student loan forgiveness tax bomb hidden in Trump's 'Big Beautiful Bill'

More than 42 million Americans have federal student loan debt totaling a whopping $1.7 trillion.

Buried deep in President Donald Trump’s sweeping “One Big Beautiful Bill” (OBBB) is a provision making most student loan forgiveness taxable again starting in 2026. This means that more than 12 million borrowers on income-driven repayment (IDR) plans will start paying taxes on their forgiven debt.

The twist? Most borrowers have no clue this tax bomb is coming, leaving them woefully unprepared in a precarious position, experts say.

How the federal student loan forgiveness tax changes work

The pandemic-era American Rescue Plan Act of 2021 (ARPA) made most federal student loan forgiveness tax-free through the end of 2025. Borrowers with IDR plans make reduced payments, calculated based on their income and family size, for 20 to 25 years, according to the U.S. Department of Education.

The biggest perk of IDR plans is that if borrowers haven’t fully repaid their loan by the end of the term, the remaining balance is forgiven. Through the end of this year, that forgiveness won’t be taxed as income.

But that’s about to change. Beginning Jan. 1, 2026, the IRS will tax borrowers with IDR plans for their forgiven federal student loan debt. This could result in an unexpected tax bill of $7,000 to $12,000, financial aid expert Mark Kantrowitz told CNBC.

The new tax changes are setting IDR borrowers up for a tax bomb they won’t see coming because the forgiven balance could push them up into a higher tax bracket, said Jack Wang, a college financial aid advisor and host of the Smart College Buyer podcast.

Additionally, more states might tax student loan forgiveness to stay in step with federal tax policy, adding to your state tax bill, Wang noted. Currently, borrowers in five states — Arkansas, Indiana, Mississippi, North Carolina and Wisconsin — must pay state income taxes on some federal student loan forgiveness.

Let’s look at an example. Consider a teacher earning $50,000 a year who gets $40,000 in federal student loan forgiveness in 2026. That means her total taxable income is pushed up to $90,000 for the year, bumping her from the 12% tax bracket into the 22% tax bracket.

Instead of owing roughly $5,780 in federal taxes on her salary alone, now she owes approximately $15,125 in federal taxes on her combined income — a surprise tax bomb of $9,345. And if she’s in one of the five states that tax student loan forgiveness, she’ll shell out another $2,000 to $4,000 in state income taxes, bringing her total surprise tax burden to over $11,000.

Meanwhile, some forgiveness programs will remain tax-exempt, including Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness. But it’s worth noting that many borrowers who use these programs combine them with IDR plans. If you die or become completely and permanently disabled, your forgiven debt will continue to be exempt from federal taxes under the new tax code.

New federal rules reshaping higher education

The tax changes and other bill provisions deemphasize the federal government’s role in helping families pay for higher education, putting more responsibility on families to foot the bill. This might mean a greater push into private lending; however, private loans have stricter credit and financial underwriting rules and have fewer borrower protections than federal loans.

The private market has evolved to fill some of these gaps through product offerings, but the dialogue is ongoing, said Sara Parrish, president of CampusDoor, a third-party student and specialty loan origination platform.

In addition to taxing some student loan forgiveness, other provisions in President Trump’s tax bill could make it harder for middle- and lower-income families to afford college. Some of those provisions, which take effect July 1 2026, include:

• Creating the Repayment Assistance Plan (RAP), a new, streamlined IDR plan that goes into effect July 1, 2026. It requires a minimum payment of at least $10 a month, regardless of income or family size. However, RAP only provides debt forgiveness after 30 years of qualifying payments, whereas existing IDR plans cancel the debt after 10 to 25 years.
• Eliminating Grad PLUS Loans for graduate and professional programs that previously allowed students to borrow up to the full cost of attendance.
• Phasing out the Biden-era Saving on a Valuable Education (SAVE) plan, which began re-accruing interest on Aug. 1 for 7.7 million federal student loan borrowers, according to the Education Department. After July 1, 2028, the only two IDR plan options will be the RAP and the income-based repayment (IBR) plan.
• Reducing the annual amount that part-time students may borrow in an academic year (details are forthcoming on these limits from the Education Department over the next year).
• Limiting Parent PLUS loans to $65,000 per student lifetime and $20,000 annually. 

Another new wrinkle could also curtail the PSLF program access. On Aug. 18, the Department of Education issued a notice of rulemaking that seeks to limit which employers qualify for PSLF. The proposed rules apply to employers or organizations that are believed to support terrorism, child abuse, or aid or abet in discrimination or violations of immigration laws, the Education Department said. The vaguely-worded guidance means the Trump administration has broad discretion in deciding which companies should qualify for PSLF, potentially limiting employees' choices of where to work if they want their student loan debt forgiven.

Combined, these changes could make it harder for families to afford higher education, resulting in tough conversations and decisions ahead, Parrish said.

“The way that people are thinking about post-secondary education seems to be changing,” Parrish said, adding that students need to ensure the degrees they pursue will have a strong return on investment after graduation. She advises students to fill out the Free Application for Federal Student Aid (FAFSA) and exhaust federal aid as a first step, as well as applying for scholarships and grants.
“You need to evaluate the federal tools first and look at private lending as gap financing,” Parris said, recommending that students also look at state-based nonprofit lenders. Nonprofit lenders typically offer competitive interest rates, longer loan terms and more flexible repayment options, Parrish said.

How to prepare for a potential student loan forgiveness tax bomb

So what happens if you can’t afford this unexpected tax bill?

“The IRS is not your typical creditor,” Wang said. “It's not like you're defaulting on a credit card. When you default on a tax liability, the IRS has a lot more tools than other lenders.”

For instance, the IRS can garnish your wages and withhold money from your tax refund to collect what you owe to Uncle Sam. If the IRS garnishes wages, that can impact your credit and have a trickle-down effect on your personal finances, Wang noted.

For those facing potential tax bills from forgiveness down the road, Wang suggests restructuring your finances now to prepare. Here are some tips to help.

1. Do basic math to project your potential loan forgiveness amount and multiply it by your expected tax rate. Several online calculators can help you crunch the numbers.
2. Start saving a small amount in a high-yield savings account that will earn interest over time.
3. Carefully review your budget and find ways to set aside money over time by cutting back on some discretionary spending.
4. Be proactive about planning ahead so you’re not shocked by a large tax bill in the year loan forgiveness occurs.

With the Federal Reserve estimating that 40% of families are unable to cover a $400 emergency expense, preparing for a potential tax bill totaling thousands of dollars will be a tall order, especially for lower- and middle-income families. That’s why now is the time to start saving and preparing, Wang said.