Student Loan Forgiveness and Your Taxes: How State and Federal Could Vary
One of the hot topics after the Biden administration unveiled its student loan forgiveness plan last week was how canceled debt might impact borrowers’ income tax returns. The details are still not clear, though the plan could have tax consequences, depending on where you live.
The plan will forgive $10,000 to $20,000 in federal student debt for borrowers who meet certain income requirements. It isn’t expected to trigger any tax consequences on federal returns, CNBC reported. That’s mainly because the American Rescue Plan of 2021 made student loan forgiveness tax-free through 2025 — and the Biden forgiveness plan is covered under that law, according to a White House fact sheet.
The IRS typically treats federal student loan forgiveness as taxable earnings, but there are exceptions. For example, the usual tax laws don’t apply to borrowers who qualify for Public Service Loan Forgiveness, a federal program that waives the remaining balance of Direct Loans for teachers and other civil servants who have made 10 years’ worth of payments.
The different rules have created confusion on the part of many borrowers, though it seems likely that those who qualify for forgiveness under the new plan won’t face federal tax liability.
At the state level, however, things are a little cloudier. The Tax Foundation, an independent tax policy nonprofit, noted in a column last week that some states might consider student loan debt forgiveness a taxable event, meaning borrowers would have to pay state income taxes on the canceled debt.
According to the Tax Foundation, 13 states “have the potential” to tax cancelled student loan debt, though the final number “could be significantly smaller” if states make legislative changes or determine that debt forgiveness can be excluded.
The 13 states cited are Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin. The maximum likely state income tax liability ranges from $307 in Pennsylvania to $1,100 in Hawaii, with most states in the $500-$700 range.
The Tax Foundation further states that while the forgiven debt itself would have been paid over a period of years, the debt cancellation is included in income for the tax year in which the debt was forgiven. So, loans forgiven in 2022 would have to be accounted for on 2023 tax returns (for tax year 2022).
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If you live in one of those 13 states, don’t worry about taxes just yet. As the Tax Foundation noted, states will likely issue tax guidance on discharged student loan debt in the coming weeks and months. The best advice for now is to wait until you learn more.
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