The collision happened at a crossing on a track just off the A458 Shrewsbury to Welshpool road at around 1.45pm on Monday.
An air ambulance was sent to the scene next to Powys Boarding Kennels along with police and firefighters and the driver of a black Mercedes van was airlifted to hospital.
The full extent of the driver's injuries have not yet been confirmed. No train passengers are thought to have been hurt and those onboard were transported onwards by bus.
Interactive map of the area:
No trains were running on the single-track Cambrian Line between Aberystwyth and Shrewsbury on Monday afternoon as a result of the crash.
The collision did not happen on the main crossing on the A458 at Buttington but on a track around 40 metres off the main road further towards Trewern.
The A458 was closed for a period as a result but was back open by 4pm with traffic calming measures in place.
A British Transport Police spokesman said: "British Transport Police were called at 1.52pm to a level crossing in Buttington, Welshpool, following a report between a collision between a vehicle and a train.
"The driver of the vehicle suffered serious injuries and has been taken to hospital. Officers remain at the scene."
The badly-damaged van involved in the crash was still at the scene at 4.30pm but the train had been moved.
One resident, who asked not to be named, said: “I didn’t see what happened or hear anything. All I saw was all the police and emergency services arriving. It’s very sad.
"The road was blocked up to traffic. I had to start work late because of it. I’ve not been here that long but I know there have been quite a few accidents here in the past.”
Dave Ryan, who lives nearby in Station View, saw all the passengers from the train waiting for a replacement bus near his house.
He said the incident was a grim reminder for residents who have seen multiple crashes in the area over the years.
“I remember hearing a loud bang out here one night and poking my head out of the door to see a head on collision.”
He pointed out a couple of spots nearby where crashes had happened and added: “I saw them all waiting for their bus. It sounds like it was a bad crash. It’s not what you want to hear.”
Graham Williams, another resident nearby, said: “I do feel for those involved. It’s tough to deal with. Its been a terrible year.”
Lloyds Coaches are providing replacement road transport serving all stations in both directions between Aberystwyth and Shrewsbury.
A Welsh Ambulance Service spokesperson said: “We were called today, Monday 22 June at approximately 1.48pm to reports of transportation incident in the Cefn area of Welshpool.
"We sent one rapid response vehicle, three emergency ambulances and the Wales Air Ambulance to the scene.”
The driver was airlifted to Royal Stoke University Hospital.