Student loan borrowers are facing a ticking time bomb that could result in an “enormous tax liability.” That’s according to a lawsuit filed against the Department of Education in the U.S. District Court for the District of Columbia.
The complaint alleges that the Department of Education withheld income-driven repayments plans and their benefits. That delay, combined with a looming change in the tax laws, could potentially result in harm to millions of borrowers, including a huge tax bill for some of them, if the Department does not cancel their loans before January 1, 2026.
Background
In 1965, Congress passed the Higher Education Act because to give students additional options to pay for college. Nearly three decades later, in 1994, Congress amended the HEA and established the William D. Ford Federal Direct Loan Program, which expanded the government’s ability to directly lend money to students. As a result, the student loan system shifted from one primarily involving private lenders to one where the U.S. government became the main creditor of student loans.
At the same time, Congress directed the Department of Education to offer students additional loan repayment options, including some that tied the borrower’s monthly payment to their income. Those plans are known as income-driven repayment (IDR) plans.
One of these plans was an income-based repayment (IBR) plan. The IBR allowed an “income-based” affordable repayment option for borrowers who found it difficult to pay their full loans. There was also an income-contingent repayment plan (ICR)—the statute creating the ICR was passed in 1993.
Eventually, because of the ICR statute, borrowers had access to three plans: the Income-Contingent Repayment Plan (ICR Plan), the Pay As You Earn plan (PAYE Plan), and the Revised Pay As You Earn plan (REPAYE Plan, later renamed and made more generous as the SAVE Plan). However, under the One Big Beautiful Bill Act (OBBBA), the ICR, PAYE, and SAVE plans will sunset as of July 1, 2028. The IBR plan will remain available indefinitely.
No matter the specific plan, typically, whenever a borrower satisfies the statutory repayment obligations under an IDR plan, their loans should be automatically cancelled after 20 or 25 years. The borrower shouldn’t have to take any other steps for relief. (Under the OBBBA, most new borrowers will have to wait 30 years.)
The Complaint
The complaint alleges that the Department of Education withheld IDR plans and their benefits from millions of borrowers.
Specifically, in February of 2025, the Department of Education blocked access to all IDR and online loan consolidation applications without warning, impacting over 12 million student loan borrowers who rely on those plans. The government pointed to an 8th Circuit Court of Appeals order that blocked the SAVE plan as the basis for the pause. In response, the ATF filed suit against the Department of Education, claiming that the stoppage was applied too broadly. One day after the lawsuit was filed, the Department of Education announced that it would reopen the online application. For many, the damage had already been done.
While applications were offline, borrowers in an IDR couldn’t recertify their income (an annual requirement for such plans), leading to higher monthly bills. Others who had been enrolled in the Public Service Loan Forgiveness (PSLF) program and were in forbearance due to the suspension of the SAVE plan, were unable to enroll in an alternative plan that could help them earn credit toward forgiveness. Those borrowers lost credits that could have been applied towards the debt cancellation, resulting in a significant (and potentially expensive) delay.
While some of these plans have been restored, the ATF claims that more than a million borrowers still lack access to benefits, contrary to laws passed by Congress. The same is true, claims the ATF, when it comes to the PSLF program, which offers forgiveness after 10 years of payments while someone is employed in the government of not-for-profit sector.
As a result, some borrowers were forced into default while others have been denied their right to have their loans canceled through IDR or PSLF. For those borrowers, it means that those debts remain outstanding.
And while the Department of Education is processing some pending IDR applications, they are moving very slowly. According to the complaint, as of July 31, 2025, there were 1,386,406 pending applications, but the Department’s processing rate and the rate of new applications being filed result in only an average net decrease of 87,823 applications per month. That means it could take well over a year to work through the existing inventory.
Tax Consequences
It’s not just the passage of time that’s worrisome—it’s what follows. Before March 2021, when borrowers met the statutory requirements for loan cancellation under one of the IDR plans, the canceled amount was usually considered taxable income.
That’s consistent with existing tax laws. When you can’t pay what you owe—for example, a large credit card balance—the lender may agree to discharge all or part of the debt. That could be the result of a negotiation where you agree to pay less than you owe for the lender to leave you alone, or it could be a default. Either way, the result is the same: the lender has forgiven some part (or all) of your debt. For federal tax purposes, that amount is treated as income unless you meet an exclusion or exemption.
Although some student loan cancellation programs like PSLF are specifically exempt from federal income taxes, IDR cancellation is not one of them.
That’s where the American Rescue Plan Act of 2021 (ARPA) makes a difference. Under ARPA, the cancellation of federal student loans does not result in a taxable event for federal income tax purposes for discharges occurring after December 31, 2020, and before January 1, 2026.
Borrowers who qualify for loan cancellation through the end of 2025 are still entitled to this tax treatment by law. But OBBBA didn’t extend this protection for borrowers, except for loans cancelled due to death or disability. That means that if the Department of Education does not process cancellations before the end of the year, those borrowers will not qualify for the exemption. In other words, the complaint alleges, “these borrowers will literally pay for the government’s inaction.”
That bill could be substantial. According to the Education Data Initiative, the average federal student loan debt balance is $39,075, while the total average balance, including private loan debt, may be as high as $42,673. Assuming an average marginal income tax rate of 14.5% (that was the average in 2022, according to the Tax Foundation), that would result in an extra federal income tax of between $5,666 and $6,188.
(You can see the 2025 tax brackets here.)
State taxes may also apply. While no state completely mirrors the federal system, about three dozen states and the District of Columbia connect to the federal tax rules on a rolling or static basis. In a rolling state, federal tax law changes automatically impact the state’s tax code, whereas in a static state, state legislators must pass legislation to adopt federal changes. As of the start of 2023, 18 states and the District of Columbia used a rolling basis, and 18 states used a static basis.
Class Action
The updated legal challenge was filed by the American Federation of Teachers (AFT). The initial lawsuit was filed in March, but the updated filing now seeks class action status.
A class action allows one or more plaintiffs to file a legal action on behalf of a group, called a class. The idea is to allow a large group of individuals who have allegedly suffered similar harm to join together and file a single suit—keeping the court’s caseload manageable. Typically, if a lawsuit is certified as a class action, members of the class are bound by the outcome and can’t bring their own case to court.
To file as a class action, the plaintiffs and the class must have common (though not identical) stories resulting in similar harm. In this case, the six named plaintiffs (Lisa Naugle, Kiva Iverson, Philip Whitley, Sandy Cashman, Rachel Dubreuil, and Theodore Wegner) claim that they will be subject to damages, including tax consequences, if the Department of Education doesn’t act quickly.
Who’s Who In The Case
The U.S. government through the Department of Education is the country’s largest creditor of student loans. Today, there are nearly 43 million federal student loan borrowers, with approximately $1.62 trillion outstanding in debt. The Department of Education did not respond to a request for comment.
The AFT, which is headquartered in Washington, D.C., is an affiliate of the AFL-CIO and represents 1.8 million members in more than 3,000 local affiliates nationwide. Members include pre-K through 12th-grade teachers; paraprofessionals and other school-related personnel; higher education faculty and professional staff; federal, state, and local government employees; and nurses and other healthcare professionals. In addition, the AFT represents approximately 80,000 early childhood educators and nearly 250,000 retiree members.
The ATF is represented by Berger Montague, a commercial litigation and class action law firm, and Protect Borrowers (formerly known as the Student Borrower Protection Center). Protect Borrowers was founded in 2018 to confront the $1.7 trillion student debt crisis by former Consumer Financial Protection Bureau (CFPB) officials with a grant from the Sandler Foundation. The Sandler Foundation was founded in 2001 by bankers Herbert and Marion Sandler, now both deceased. (Before they started giving their money away, the Sandlers were on Forbes’ list of the 400 richest Americans.)
Next Steps
The case is important, according to Protect Borrowers’ Persis Yu, its managing counsel, because borrowers have a legal right to Income-Driven Repayment and Public Service Loan Forgiveness. “These programs are critical to protecting the finances of millions of student loan borrowers,” she told Forbes. “By blocking access to those programs, the U.S. Department of Education is raising both short term and long terms costs for borrowers struggling to provide for their families while navigating a chaotic student loan system.”
The tax piece makes it even worse, Yu explains. If borrowers who are legally entitled to have their loans cancelled don’t get relief before the end of the year, they could face an unaffordable and unnecessary tax bill.
Last month, 11 Senators, including Bernie Sanders (I-Vermont), ranking member of the Committee on Health, Education, Labor, and Pensions, wrote a letter to Education Secretary Linda McMahon, expressing “strong opposition” to the suspension of forgiveness under the Income-Based Repayment (IBR) Program and demanding information about the delay. “Unless the department acts quickly to ensure that all borrowers entitled to forgiveness under IBR receive that forgiveness as soon as possible,” the Senators wrote, “borrowers who should receive forgiveness before the tax exemption expires could face significant tax bills on debt relief that should have been granted to them without penalty.”
These borrowers, the complaint states, “simply want to pay back their student loans according to the terms that Congress, and their contracts, provide.”
Protect Borrowers urged Congress to take action to protect borrowers but notes that “borrowers should not need Congress to act in order to get the relief they entitled to under the law right now.” A motion hearing is scheduled for October 31, 2025.