For borrowers set to receive as much as $20,000 in student loan forgiveness, the sense of relief might be tempered by the realization that they could owe state income taxes on the debt reprieve. But some states are working to change that by ensuring that student debt relief won’t count as taxable income.
President Joe Biden announced last week that he would forgive up to $10,000 in federal student loan debt for people who make less than $125,000 per year, and up to $20,000 for borrowers who attended college with Pell Grants, which are designed to help low-income students.
That debt relief could be subject to income taxes in six states, according to an analysis by the Tax Foundation, an independent nonprofit focused on tax policy.
How will student loan forgiveness affect my taxes?
In general, when debt is forgiven, it is considered income and is almost always taxable, says Jared Walczak, vice president of state projects at the Tax Foundation. Under the federal American Rescue Plan Act, student debt forgiven between 2021 and 2025 won’t be included in federal taxable income. But state income tax policies still vary.
“Because of a change in federal law, there will not be any federal tax liability if your student loan debt is forgiven or reduced. But in six states—Arkansas, Massachusetts, Minnesota, Mississippi, North Carolina, and Wisconsin—at least as of now, there would be taxes on the student loan debt forgiveness,” Walczak says. “Taxpayers in these states just need to be aware that there is likely to be a tax hit associated with receiving this debt forgiveness.”
Borrowers who receive $10,000 in debt forgiveness could be liable to pay up to $490 in Arkansas and up to $985 in Minnesota, but taxes will depend on income, according to Walczak’s analysis.
Which states could tax student loan forgiveness?
A report by the Tax Foundation originally published last week had included 13 states on a list of those that could tax student loan debt forgiveness, but the list was based on outdated tax policies in some states. Other states—including Pennsylvania and New York—clarified their policies in the past few days and said that the cancellation of student loan debt would not count as taxable income.
“Income imputed from this new loan forgiveness program will not be taxable, unless the state Legislature and Governor affirmatively decide to tax it, which is not expected,” said a spokesperson for the New York State Department of Taxation and Finance.
There are now six states that could tax student debt forgiveness, according to the Tax Foundation. They could still take legislative action in the coming months to exempt student debt relief from taxable income, but they face a deadline of finalizing those policies before people begin filing their taxes in early 2023.
“The biggest issue is that there will be a narrow window in which they can realistically act,” Walczak says.
In Massachusetts, where borrowers could be required to pay $500 in taxes on their debt relief, Governor Charlie Baker suggested that the state plans to follow federal policy. “The state, like other states, is waiting for federal guidance in how it’s going to work and once we get the guidance we’ll basically interpret that in terms of existing state law. I don’t know the answer at this point,” he said, according to local station WWLP.
Biden’s student debt forgiveness policy is controversial, with some progressive leaders arguing it didn’t go far enough to help borrowers and some conservatives arguing it’s unfair and could worsen inflation. But state leaders who consider taxing the debt relief could find that’s also an unpopular move.
“What we’re generally seeing right now is that policymakers, Republicans and Democrats, are seeking to avoid this tax hit for their residents,” Walczak says. However, he notes the ongoing political debate over the merits and legality of Biden’s student loan forgiveness.
“There’s an important political debate taking place here, but at the state level, the question of whether to tax this canceled debt does not seem to be tracking with that debate,” he says. “Most policymakers don’t seem eager to impose a tax on debt forgiveness.”
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