Abstract

On July 4, 2025, President Trump signed into law the congressional budget reconciliation bill known as the “One Big Beautiful Bill Act” (OBBBA). The OBBBA delivers over $4 trillion in tax cuts to billionaires and large corporations, while making unprecedented cuts to Medicaid, the Supplemental Nutrition Assistance Program (SNAP), federal student aid, and many other programs that working families rely upon to make ends meet.

Among the many enormous policy changes made by the OBBBA, Congress made permanent the exclusion of cancelled student loan debt due to death or permanent disability from federal taxable income. In the Tax Cuts and Jobs Act of 2018, Congress originally exempted loans cancelled due to death or permanent disability from federal taxation from December 31, 2017, until December 31, 2025. Congress later expanded this federal tax exemption to include all cancelled federal student debt, including through Income-Driven Repayment (IDR) plans, as part of the American Rescue Plan Act of 2021. While the OBBBA permanently extended the exclusion of cancelled debts for death and disability, millions of borrowers who are currently on track to earn debt relief under an IDR plan after January 1, 2026, will see a massive increase in their federal income tax liability and therefore have to pay thousands of dollars in additional taxes.

The following memo provides an overview of the additional tax costs that working families could face if Congress and the Trump Administration fail to act.

Summary:

The Protect Borrowers memorandum paints a grim picture for borrowers approaching Income-Driven Repayment (“IDR”) forgiveness after January 1, 2026. Congress preserved tax-free treatment for student loans discharged due to death or disability, but allowed the broader American Rescue Plan Act exclusion for IDR forgiveness to expire.

That means borrowers who spent twenty to thirty years making payments under IDR plans may suddenly receive IRS Form 1099-C cancellation-of-debt income for balances that often ballooned because of negative amortization and interest capitalization. The report estimates that borrowers receiving average IDR forgiveness of roughly $49,321 could face additional federal tax liabilities ranging from approximately $5,800 to more than $10,000, with lower-income families often suffering the greatest harm because they simultaneously lose refundable tax credits such as the Earned Income Tax Credit and Additional Child Tax Credit.

The examples are staggering. A married borrower with two dependents earning $40,000 annually could move from receiving $8,534 in refundable credits to owing $1,761 in taxes—a net swing of more than $10,000. The memorandum also highlights borrowers whose balances exploded from ordinary educational debt into six-figure obligations through decades of capitalization, deferments, and servicer misconduct. One borrower who originally borrowed $42,000 reportedly saw her balance grow to $178,000 and could face over $45,000 in tax liability if that balance is forgiven and treated as taxable income.

Importantly for bankruptcy practitioners, the memorandum briefly acknowledges that borrowers may avoid cancellation-of-debt taxation if the debt is discharged in a Title 11 bankruptcy proceeding. That observation may prove far more significant than the memorandum itself recognizes.

Commentary:

For years, the conventional wisdom was that bankruptcy and student loan forgiveness occupied separate universes. Bankruptcy lawyers handled insolvency; IDR and PSLF belonged to the federal student loan servicing system. Increasingly, however, those worlds are colliding.

The key development is 34 C.F.R. § 685.209(k)(4)(iv)(K), which provides that periods during which a borrower is in a qualifying bankruptcy forbearance while making required Chapter 13 plan payments count toward IDR forgiveness and PSLF credit. Put simply, Chapter 13 has become “time served” toward eventual student loan discharge.

That changes everything.

A debtor can now spend three to five years in Chapter 13 obtaining the protections of the automatic stay, curing mortgage defaults, stopping garnishments, dealing with tax debt, managing unsecured claims, and simultaneously accumulating qualifying IDR or PSLF credit months. Once those repayment periods are completed, the borrower may emerge entitled to substantial federal student loan forgiveness.

The OBBBA memorandum demonstrates why the tax consequences of that forgiveness now matter enormously. If Congress allows IDR forgiveness taxation to return in full force, many borrowers will merely exchange one impossible debt for another: federal student loans replaced by IRS liabilities.

But bankruptcy practitioners should immediately notice something unusual in the IRS instructions for Form 982.

The IRS defines a “Title 11 case” as one in which “the discharge of indebtedness is granted by the court or is under a plan approved by the court.”

That language is fascinating.

The phrase “granted by the court” obviously covers ordinary bankruptcy discharges under Chapters 7, 11, 12, and 13. But the IRS did not stop there. Instead, it separately included debt forgiveness that occurs “under a plan approved by the court.”

Those clauses must mean different things.

Otherwise, the second clause becomes surplusage.

That opens a potentially powerful argument: where a confirmed Chapter 13 plan expressly provides for treatment of student loans while the debtor accrues qualifying “time served” IDR or PSLF credit pursuant to federal regulations, the eventual forgiveness may arguably occur “under a plan approved by the court” even if the actual discharge event occurs administratively years later.

That is not a frivolous argument.

Indeed, Chapter 13 confirmation orders routinely approve long-term debt treatment under § 1322(b)(5), mortgage modifications, conduit payments, cure provisions, direct-pay obligations, and increasingly complex student loan provisions. If the confirmed plan expressly contemplates and incorporates the federal regulatory framework under which Chapter 13 plan performance generates qualifying IDR credit, one can reasonably argue that the eventual forgiveness is inextricably tied to and accomplished under the authority of that court-approved plan.

At minimum, this creates a substantial interpretive issue under Internal Revenue Code § 108 and the IRS’s own published guidance.

And unlike many aggressive tax theories, this one arises directly from the government’s own language.

Bankruptcy May Become the Safest and Cheapest Path to Student Loan Forgiveness:

Ironically, the OBBBA may push more borrowers toward Chapter 13 precisely because Chapter 13 could become the best available shield against the tax bomb Congress just recreated.

That is especially true for borrowers who:

are already pursuing PSLF or IDR forgiveness;
have substantial accrued interest capitalization;
cannot realistically repay their balances;
face renewed collection efforts and wage garnishment;
need mortgage or vehicle relief; or
have low enough income that insolvency analyses would be difficult, expensive, or uncertain.

The memorandum correctly notes that the insolvency exception is cumbersome and inaccessible for many borrowers. Bankruptcy, however, already requires a judicially supervised accounting of debts, assets, disposable income, and repayment obligations. In many cases, Chapter 13 may provide a cleaner and more defensible framework for excluding future cancellation-of-debt income.

There is also a practical reality here.

The IRS instructions themselves acknowledge that debts discharged “under a plan approved by the court” qualify for exclusion treatment. At the same time, the IRS has suffered substantial staffing reductions and operational strain. Even if Treasury ultimately disputes this interpretation, one suspects the agency may have limited appetite for litigating highly technical cancellation-of-debt issues involving financially distressed borrowers who completed multi-year Chapter 13 plans in reliance on federal student loan regulations.

And politically, suing debtors who spent five years in Chapter 13 while attempting to comply with federal repayment programs is probably not the cleanest test case.

Final Thoughts:

For decades, the nightmare scenario for student loan borrowers was that balances would survive bankruptcy. Increasingly, however, the greater danger may be what happens after forgiveness.

Congress appears poised to recreate the very “tax bomb” that earlier legislation temporarily neutralized. Yet in doing so, it may inadvertently increase the importance of Chapter 13 bankruptcy as both a student loan management tool and a tax planning mechanism.

That possibility should not be ignored.

Consumer bankruptcy attorneys should begin thinking now about plan language specifically addressing IDR and PSLF “time served” credit under 34 C.F.R. § 685.209(k)(4)(iv)(K), the relationship between confirmed plans and future administrative forgiveness, and whether that forgiveness may ultimately qualify as debt discharged “under a plan approved by the court” for purposes of Form 982 and Internal Revenue Code § 108.

Because if that argument succeeds, Chapter 13 may become not merely a bridge to student loan forgiveness, but the mechanism that preserves the value of that forgiveness itself.

To read a copy of the transcript, please see: