A federal court has formally suspended a legal challenge over stalled student loan forgiveness, ruling that staying the proceedings was necessary due to the ongoing government shutdown. The move could have major financial repercussions for many borrowers who qualify for loan forgiveness now but may incur significant tax consequences if relief is delayed into next year.
The ongoing government shutdown has halted other litigation involving the Trump administration in cases throughout the country. Justice Department attorneys and support staff are not allowed to work after appropriations have lapsed, which leaves the department with no choice but to ask judges to stay (or halt) the legal proceedings until funding has been restored by Congress. But with no end in sight to the ongoing shutdown, an extended lapse in government funding could have major consequences for some student loan borrowers. Here’s the latest.
Legal Challenge Over Delayed Student Loan Forgiveness
In September, the American Federation of Teachers updated its existing lawsuit that it had filed last March over massive processing delays for income-driven repayment plans. IDR plans offer borrowers affordable monthly payments based on income, with the possibility of student loan forgiveness after 20 or 25 years in repayment. IDR plans can also lead to loan forgiveness in as little as 10 years through Public Service Loan Forgiveness, or PSLF, for those who work full-time in nonprofit or government careers.
But the AFT alleged in its legal challenge that the Trump administration had unlawfully halted IDR processing, worsening an existing IDR application backlog. That, the AFT argued, effectively prevented borrowers from pursuing student loan forgiveness under IDR and PSLF. The Trump administation disputed this, arguing that the Department of Education had no choice but to pause application processing following a new court order in the ongoing legal challenge over the SAVE plan.
In updated legal documents filed in September, the AFT broadened its allegations. The AFT argued that the Department of Education’s efforts to dent the massive IDR application backlog was unsuccessful, with more than a million applications still in the queue and more than 400,000 applications expected to be automatically rejected due to technicalities. The AFT also argued that the department was not sufficiently processing applications for PSLF Buyback, which offers PSLF borrowers an alternative path to loan forgiveness by making a lump sum payment covering certain prior periods of deferment or forbearance. And the AFT contended that the Trump administration was illegally blocking student loan forgiveness under the IBR, ICR, and PAYE plans.
Shortly after filing its amended complaint, the AFT filed a motion for a preliminary injunction, an emergency request asking the court to issue an interim order that would require the department to take immediate action even before the merits of the AFT’s legal challenge are fully decided. Specifically, the AFT noted that tax relief associated with the American Rescue Plan Act of 2021 is set to expire at the end of this year. When that happens, student loan forgiveness under IDR plans will become taxable events again. The AFT argued that the department’s ongoing delays will cause many borrowers who are eligible for relief now to not receive the loan forgiveness they are entitled to under federal law until next year, which could lead to massive unaffordable tax bills.
“Beginning January 1, 2026, the provision of federal tax code that provides student loan cancellation shall not be considered a taxable event for federal income tax purposes will expire,” said the AFT in its motion for a preliminary injunction. “Although some student loan cancellation programs are specifically exempt from federal income taxes, such as PSLF, see 26 U.S.C. § 108(f)(1), IDR cancellation is not one of them. Therefore, any borrower who is currently eligible to have their loans cancelled under an IDR plan, such as the IBR plan, but whose cancellation is being withheld by the Department, risks this cancellation being taxed as federal income if the cancellation is not processed before January 1, 2026.”
The AFT also noted that the Trump administration restarted interest accrual for SAVE plan borrowers earlier this summer, which will only exacerbate the tax consequences associated with student loan forgiveness.
“For borrowers who have satisfied the requirements to have their loans cancelled under the IDR statute but from whom the Department is illegally withholding loan cancellation, accruing interest will increase their account balance and will increase their tax liability if their loan cancellation is not processed before the January 1, 2026 tax deadline.”
Court Suspends Student Loan Forgiveness Legal Challenge
Last week, the judge overseeing the AFT’s legal challenge over stalled student loan forgiveness agreed to halt the proceedings at the request of the Department of Justice.
“In accordance with the attached Order, it is hereby ORDERED that briefing on the Plaintiffs’ Motion For Preliminary Injunction is STAYED until Congress restores appropriations to the U.S. Department of Justice,” said the court in its ruling.” The court also cancelled an upcoming hearing scheduled for October 31st on the AFT’s motion for a preliminary injunction and its request to convert the legal challenge into a class action lawsuit.
“Once Congress restores appropriations, the parties shall confer regarding a date for the Court to hear arguments on the plaintiffs’ motions for a preliminary injunction and class certification,” continued the court in its order. “It is further ORDERED that once Congress restores appropriations to the U.S. Department of Justice, the parties’ filing deadlines regarding the plaintiffs’ motions for preliminary injunction and class certification shall be EXTENDED by the number of days equal to the length in days of the lapse of appropriations plus ten days.”
“It is further ORDERED that if the plaintiffs request to set a new briefing schedule and hearing date for their motion for a preliminary injunction and class certification before the lapse in appropriations ends, the plaintiffs shall file such request on or before October 10, 2025,” said the court. The AFT filed no such papers prior to that deadline.
The order may jeopardize the ability of the AFT, on behalf of thousands of student loan borrowers who could be potential class members, to compel the Department of Education to implement relief for qualifying borrowers prior to January 1, 2026. That could leave borrowers who qualify for student loan forgiveness now, but haven’t received relief yet, exposed to major tax consequences next year.
Shutdown Could Impact Student Loan Forgiveness Approvals For IBR
Earlier this month, the Department of Education began sending out student loan forgiveness approval notices for borrowers enrolled in the IBR plan who had reached the 25-year threshold, apparently signalling an end to the IBR processing pause that the department had quietly announced earlier this summer. The department did not release a public comment announcing the approvals, and it is unclear if the wave of approval notices was tied to the AFT’s legal challenge.
But student loan forgiveness under IBR is not immediate, even when a borrower is approved. According to the notices, borrowers have until later in October to “opt out” of loan forgiveness if they wish. Only after that opt-out date will the department notify loan servicers to discharge the applicable student loan balances. If the government shutdown continues, this process could drag out longer than expected, potentially putting these borrowers at risk of tax consequences if their discharge does not happen until January.