Wellor borrowers who will receive up to $20,000 in student loan forgiveness, the sense of relief may be tempered by the realization that they may owe state income taxes on the debt forgiveness. But some states are working to change that by ensuring that student debt relief doesn’t count as taxable income.
President Joe Biden announced last week that he would forgiveness of up to $10,000 in federal student loan debt for people making less than $125,000 a year, and up to $20,000 for borrowers who attended college with Pell Grants, which are designed to help low-income students.
This debt relief may be subject to income taxes in six states, according to analysis from the Tax Foundation, an independent nonprofit focused on tax policy.
How will student loan forgiveness affect my taxes?
Generally, when debt is forgiven, it’s considered income and almost always taxable, says Jared Walczak, vice president of government projects at the Tax Foundation. Under the federal American Rescue Plan Act, student debt forgiven between 2021 and 2025 will not be included in federal taxable income. But state income tax policies still differ.
“Due to a change in federal law, there will be no federal tax liability if your student loan debt is forgiven or reduced. But six states—Arkansas, Massachusetts, Minnesota, Mississippi, North Carolina and Wisconsin—at least now will have taxes on 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 relief.”
Borrowers who receive $10,000 in debt forgiveness could be required 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 Might Tax Student Loan Forgiveness?
A Tax Foundation report originally published last week included 13 states on a list of those that could tax student loan debt forgiveness, but the list was based on outdated tax policies in some states.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 countries – i.eincluding Pennsylvania and New York — have clarified their policies in the past few days and said that student loan debt cancellation will not count as taxable income.
“The income contingent on this new loan forgiveness program will not be taxable unless the state legislature and governor decide to tax it, which is not expected,” a spokesman for the state Department of Taxation and Finance said on New York.
There are now six states that could tax student debt forgiveness, according to the Tax Foundation. They can still take legislative action in the coming months to exempt student debt relief from taxable income, but they face a deadline to finalize those policies before people start filing taxes in early 2023.
“The biggest problem is that there will be a narrow window in which they can realistically operate,” Walczak says.
In Massachusetts, where borrowers may be required to pay $500 in taxes on their debt relief, Gov. Charlie Baker suggested the state plans to follow federal policy. “The state, like other states, is waiting for federal guidance on how it’s going to work, and once we get the guidance, we’re basically going to interpret that in terms of existing state law.” I don’t know the answer at this stage,” he said, according to local station WWLP.
Biden’s student debt forgiveness policy is controversialas some progressive leaders claim didn’t go far enough to help borrowers and some conservatives argue that it is unfair and may worsen inflation. But state leaders considering taxing debt relief may find that is also an unpopular move.
“What we typically see right now is that politicians, Republican and Democrat, are looking to avoid this tax hit for their residents,” Walczak said. However, he notes the ongoing political debate over the merits and legality of Biden’s student loan forgiveness.
“There’s an important political debate going on here, but at the state level, the question of whether to tax this canceled debt doesn’t seem to be consistent with that debate,” he says. “Most politicians seem reluctant to tax debt relief.”
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