diff --git a/registry/coder/modules/code-server/README.md b/registry/coder/modules/code-server/README.md
index d6dcd6bd7..ae0f60e62 100644
--- a/registry/coder/modules/code-server/README.md
+++ b/registry/coder/modules/code-server/README.md
@@ -14,7 +14,7 @@ Automatically install [code-server](https://github.com/coder/code-server) in a w
 module "code-server" {
   count    = data.coder_workspace.me.start_count
   source   = "registry.coder.com/coder/code-server/coder"
-  version  = "1.5.1"
+  version  = "1.6.0"
   agent_id = coder_agent.example.id
 }
 ```
@@ -29,7 +29,7 @@ module "code-server" {
 module "code-server" {
   count           = data.coder_workspace.me.start_count
   source          = "registry.coder.com/coder/code-server/coder"
-  version         = "1.5.1"
+  version         = "1.6.0"
   agent_id        = coder_agent.example.id
   install_version = "4.106.3"
 }
@@ -43,7 +43,7 @@ Install the Dracula theme from [OpenVSX](https://open-vsx.org/):
 module "code-server" {
   count    = data.coder_workspace.me.start_count
   source   = "registry.coder.com/coder/code-server/coder"
-  version  = "1.5.1"
+  version  = "1.6.0"
   agent_id = coder_agent.example.id
   extensions = [
     "dracula-theme.theme-dracula"
@@ -61,7 +61,7 @@ Configure VS Code's [User settings.json](https://code.visualstudio.com/docs/gets
 module "code-server" {
   count      = data.coder_workspace.me.start_count
   source     = "registry.coder.com/coder/code-server/coder"
-  version    = "1.5.1"
+  version    = "1.6.0"
   agent_id   = coder_agent.example.id
   extensions = ["dracula-theme.theme-dracula"]
   settings = {
@@ -81,7 +81,7 @@ Install multiple extensions from [OpenVSX](https://open-vsx.org/) by adding them
 module "code-server" {
   count      = data.coder_workspace.me.start_count
   source     = "registry.coder.com/coder/code-server/coder"
-  version    = "1.5.1"
+  version    = "1.6.0"
   agent_id   = coder_agent.example.id
   extensions = ["dracula-theme.theme-dracula", "ms-azuretools.vscode-docker"]
 }
@@ -95,7 +95,7 @@ Open a [`.code-workspace`](https://coder.com/docs/code-server/FAQ#how-does-code-
 module "code-server" {
   count     = data.coder_workspace.me.start_count
   source    = "registry.coder.com/coder/code-server/coder"
-  version   = "1.5.1"
+  version   = "1.6.0"
   agent_id  = coder_agent.example.id
   workspace = "/home/coder/project/my.code-workspace"
 }
@@ -109,7 +109,7 @@ You can pass additional command-line arguments to code-server using the `additio
 module "code-server" {
   count           = data.coder_workspace.me.start_count
   source          = "registry.coder.com/coder/code-server/coder"
-  version         = "1.5.1"
+  version         = "1.6.0"
   agent_id        = coder_agent.example.id
   additional_args = "--disable-workspace-trust"
 }
@@ -125,7 +125,7 @@ Run an existing copy of code-server if found, otherwise download from GitHub:
 module "code-server" {
   count      = data.coder_workspace.me.start_count
   source     = "registry.coder.com/coder/code-server/coder"
-  version    = "1.5.1"
+  version    = "1.6.0"
   agent_id   = coder_agent.example.id
   use_cached = true
   extensions = ["dracula-theme.theme-dracula", "ms-azuretools.vscode-docker"]
@@ -138,7 +138,7 @@ Just run code-server in the background, don't fetch it from GitHub:
 module "code-server" {
   count    = data.coder_workspace.me.start_count
   source   = "registry.coder.com/coder/code-server/coder"
-  version  = "1.5.1"
+  version  = "1.6.0"
   agent_id = coder_agent.example.id
   offline  = true
 }
diff --git a/registry/coder/modules/code-server/code-server.tftest.hcl b/registry/coder/modules/code-server/code-server.tftest.hcl
index 209a0f39d..3079e6055 100644
--- a/registry/coder/modules/code-server/code-server.tftest.hcl
+++ b/registry/coder/modules/code-server/code-server.tftest.hcl
@@ -100,3 +100,36 @@ run "workspace_extension_rejected" {
   }
   expect_failures = [var.workspace]
 }
+
+run "debug_flag_enabled" {
+  command = plan
+
+  variables {
+    agent_id = "foo"
+    debug    = true
+  }
+}
+
+run "overwrite_settings_flags" {
+  command = plan
+
+  variables {
+    agent_id                   = "foo"
+    overwrite_settings         = true
+    overwrite_machine_settings = true
+  }
+}
+
+run "settings_jsonencode_with_interpolation" {
+  command = plan
+
+  variables {
+    agent_id = "foo"
+    settings = {
+      "window.title" = "My Window"
+    }
+    machine_settings = {
+      "git.blame.editorDecoration.template" = "$${authorName}"
+    }
+  }
+}
diff --git a/registry/coder/modules/code-server/main.tf b/registry/coder/modules/code-server/main.tf
index 71db40e22..1746bf79a 100644
--- a/registry/coder/modules/code-server/main.tf
+++ b/registry/coder/modules/code-server/main.tf
@@ -44,12 +44,24 @@ variable "settings" {
   default     = {}
 }
 
+variable "overwrite_settings" {
+  type        = bool
+  description = "If true, overwrites the User settings.json instead of attempting to merge."
+  default     = false
+}
+
 variable "machine_settings" {
   type        = any
   description = "A map of template level machine settings to apply to code-server. These settings are merged with any existing machine settings on startup."
   default     = {}
 }
 
+variable "overwrite_machine_settings" {
+  type        = bool
+  description = "If true, overwrites the Machine settings.json instead of attempting to merge."
+  default     = false
+}
+
 variable "folder" {
   type        = string
   description = "The folder to open in code-server."
@@ -167,6 +179,12 @@ variable "additional_args" {
   default     = ""
 }
 
+variable "debug" {
+  type        = bool
+  description = "Enable debug mode for the code-server startup script, which dynamically runs set -x."
+  default     = false
+}
+
 locals {
   settings_b64         = var.settings != {} ? base64encode(jsonencode(var.settings)) : ""
   machine_settings_b64 = var.machine_settings != {} ? base64encode(jsonencode(var.machine_settings)) : ""
@@ -184,7 +202,9 @@ resource "coder_script" "code-server" {
     LOG_PATH : var.log_path,
     INSTALL_PREFIX : var.install_prefix,
     SETTINGS_B64 : local.settings_b64,
+    OVERWRITE_SETTINGS : var.overwrite_settings,
     MACHINE_SETTINGS_B64 : local.machine_settings_b64,
+    OVERWRITE_MACHINE_SETTINGS : var.overwrite_machine_settings,
     OFFLINE : var.offline,
     USE_CACHED : var.use_cached,
     USE_CACHED_EXTENSIONS : var.use_cached_extensions,
@@ -193,6 +213,7 @@ resource "coder_script" "code-server" {
     WORKSPACE : var.workspace,
     AUTO_INSTALL_EXTENSIONS : var.auto_install_extensions,
     ADDITIONAL_ARGS : var.additional_args,
+    DEBUG : var.debug,
   })
   run_on_start = true
 
diff --git a/registry/coder/modules/code-server/run.sh b/registry/coder/modules/code-server/run.sh
old mode 100644
new mode 100755
index 5ac2d12a2..b8ff56965
--- a/registry/coder/modules/code-server/run.sh
+++ b/registry/coder/modules/code-server/run.sh
@@ -1,5 +1,10 @@
 #!/usr/bin/env bash
 
+# Enable debug mode dynamically if the flag is true
+if [ "${DEBUG}" = true ]; then
+  set -x
+fi
+
 EXTENSIONS=("${EXTENSIONS}")
 BOLD='\033[0;1m'
 CODE='\033[36;40;1m'
@@ -19,61 +24,99 @@ function run_code_server() {
   $CODE_SERVER "$EXTENSION_ARG" --auth none --port "${PORT}" --app-name "${APP_NAME}" ${ADDITIONAL_ARGS} > "${LOG_PATH}" 2>&1 &
 }
 
-# Merge settings from module with existing settings file
-merge_settings() {
+# Merge, validate, save, and format settings.json
+save_settings() {
   local new_settings="$1"
   local settings_file="$2"
+  local overwrite="$3"
 
   if [ -z "$new_settings" ] || [ "$new_settings" = "{}" ]; then
     return 0
   fi
 
-  if [ ! -f "$settings_file" ]; then
-    mkdir -p "$(dirname "$settings_file")"
-    printf '%s\n' "$new_settings" > "$settings_file"
-    printf "⚙️ Creating settings file...\n"
-    return 0
+  local tool=""
+  if command -v jq > /dev/null 2>&1; then
+    tool="jq"
+  elif command -v python3 > /dev/null 2>&1; then
+    tool="python3"
   fi
 
+  mkdir -p "$(dirname "$settings_file")"
   local tmpfile
   tmpfile="$(mktemp)"
 
-  if command -v jq > /dev/null 2>&1; then
-    if jq -s '.[0] * .[1]' "$settings_file" <(printf '%s\n' "$new_settings") > "$tmpfile" 2> /dev/null; then
-      mv "$tmpfile" "$settings_file"
-      printf "⚙️ Merging settings...\n"
-      return 0
+  # Create or Replace settings.json
+  if [ ! -f "$settings_file" ] || [ "$overwrite" = "true" ]; then
+    if [ "$tool" = "jq" ]; then
+      jq . <(printf '%s' "$new_settings") > "$tmpfile" 2> /dev/null || printf '%s\n' "$new_settings" > "$tmpfile"
+    elif [ "$tool" = "python3" ]; then
+      python3 -c "import json,sys; print(json.dumps(json.loads(sys.argv[1]), indent=2))" "$new_settings" > "$tmpfile" 2> /dev/null || printf '%s\n' "$new_settings" > "$tmpfile"
+    else
+      printf '%s\n' "$new_settings" > "$tmpfile"
     fi
+    mv "$tmpfile" "$settings_file"
+    printf "⚙️ Creating or replacing settings file...\n"
+    return 0
   fi
 
-  if command -v python3 > /dev/null 2>&1; then
-    if python3 -c "import json,sys;m=lambda a,b:{**a,**{k:m(a[k],v)if k in a and type(a[k])==type(v)==dict else v for k,v in b.items()}};print(json.dumps(m(json.load(open(sys.argv[1])),json.loads(sys.argv[2])),indent=2))" "$settings_file" "$new_settings" > "$tmpfile" 2> /dev/null; then
-      mv "$tmpfile" "$settings_file"
-      printf "⚙️ Merging settings...\n"
-      return 0
-    fi
+  # Check if required tooling exists to facilitate the merge
+  if [ -z "$tool" ]; then
+    rm -f "$tmpfile"
+    printf "Warning: Could not merge settings (jq or python3 required). Keeping existing settings.\n"
+    return 0
+  fi
+
+  # Validate existing JSON
+  local is_valid=0
+  if [ "$tool" = "jq" ]; then
+    jq empty "$settings_file" > /dev/null 2>&1 || is_valid=1
+  else
+    python3 -c "import json,sys; json.load(open(sys.argv[1]))" "$settings_file" > /dev/null 2>&1 || is_valid=1
+  fi
+
+  if [ $is_valid -ne 0 ]; then
+    rm -f "$tmpfile"
+    printf "❌ Error: Existing settings file %s contains invalid JSON.\n" "$settings_file"
+    return 1
+  fi
+
+  # Merge to temp settings.json
+  local merge_success=0
+  if [ "$tool" = "jq" ]; then
+    jq -s '.[0] * .[1]' "$settings_file" <(printf '%s\n' "$new_settings") > "$tmpfile" 2> /dev/null || merge_success=1
+  else
+    python3 -c "import json,sys;m=lambda a,b:{**a,**{k:m(a[k],v)if k in a and type(a[k])==type(v)==dict else v for k,v in b.items()}};print(json.dumps(m(json.load(open(sys.argv[1])),json.loads(sys.argv[2])),indent=2))" "$settings_file" "$new_settings" > "$tmpfile" 2> /dev/null || merge_success=1
   fi
 
-  rm -f "$tmpfile"
-  printf "Warning: Could not merge settings (jq or python3 required). Keeping existing settings.\n"
-  return 0
+  # Update settings.json with the newly merged configuration
+  if [ $merge_success -eq 0 ]; then
+    mv "$tmpfile" "$settings_file"
+    printf "⚙️ Merging settings...\n"
+    return 0
+  else
+    rm -f "$tmpfile"
+    printf "❌ Error: %s failed to write the new settings file %s.\n" "$tool" "$settings_file"
+    return 1
+  fi
 }
 
-# Apply user settings (merge with existing if present)
+# Apply user settings (merge or overwrite based on flag)
 SETTINGS_B64='${SETTINGS_B64}'
 if [ -n "$SETTINGS_B64" ]; then
   if SETTINGS_JSON="$(echo -n "$SETTINGS_B64" | base64 -d 2> /dev/null)" && [ -n "$SETTINGS_JSON" ]; then
-    merge_settings "$SETTINGS_JSON" ~/.local/share/code-server/User/settings.json
+    # Return 1 triggers exit 1 to halt execution if validation fails
+    save_settings "$SETTINGS_JSON" ~/.local/share/code-server/User/settings.json "${OVERWRITE_SETTINGS}" || exit 1
   else
     printf "Warning: Failed to decode settings. Skipping settings configuration.\n"
   fi
 fi
 
-# Apply machine settings (merge with existing if present)
+# Apply machine settings (merge or overwrite based on flag)
 MACHINE_SETTINGS_B64='${MACHINE_SETTINGS_B64}'
 if [ -n "$MACHINE_SETTINGS_B64" ]; then
   if MACHINE_SETTINGS_JSON="$(echo -n "$MACHINE_SETTINGS_B64" | base64 -d 2> /dev/null)" && [ -n "$MACHINE_SETTINGS_JSON" ]; then
-    merge_settings "$MACHINE_SETTINGS_JSON" ~/.local/share/code-server/Machine/settings.json
+    # Return 1 triggers exit 1 to halt execution if validation fails
+    save_settings "$MACHINE_SETTINGS_JSON" ~/.local/share/code-server/Machine/settings.json "${OVERWRITE_MACHINE_SETTINGS}" || exit 1
   else
     printf "Warning: Failed to decode machine settings. Skipping machine settings configuration.\n"
   fi