These States Could Tax Your Student Loan Forgiveness

FIf borrowers are set to get as high as $20,000 student loan forgiveness, their relief may be dampened by the fact that they could still owe income taxes. But some states are working to change that by ensuring that student debt relief won’t count as taxable income.

The President Joe Biden said last week that up to $10,000 of federal student loan debt would be forgiven for those earning less than $125,000 per annum. This includes up to $20,000 for Pell Grant borrowers, who are intended to aid low-income students.

The Tax Foundation, an independent, non-profit focused exclusively on tax policy, found that debt relief might be subject to income tax in six states.

Is student loan forgiveness possible to my taxes?

Jared Walczak (Vice President of State Projects at Tax Foundation), says that debt forgiven is generally considered income, and almost always taxable. 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.

What states might tax forgiveness of student loans?

Original publication by Tax Foundation last week included thirteen states on a list that would allow student loan forgiveness taxation. But the list was built on old tax policies. 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.

According to the Tax Foundation, six states could now tax student debt forgiveness. While they may still be able to take legislation in the next months in order to exempt student loans from taxable income tax, there is a deadline before students can begin filing taxes in early 2023.

“The biggest issue is that there will be a narrow window in which they can realistically act,” Walczak says.

Massachusetts Governor Charlie Baker said that Massachusetts will follow the federal policy. Borrowers could have to pay up to $500 to tax their relief from debt. “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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