Some States Could Tax Cancelled Student Loan Debt
There was some good tax news in President Biden’s student loan debt cancellation announcement—i.e., that you won’t pay federal income tax on your forgiven student loan debt. That’s notable because under the 2022 student loan forgiveness plan, some borrowers will be eligible for up to $20,000 in student loan debt cancellation. But there’s another important tax question out there involving student loans: will you have to pay state taxes on your forgiven student loan?
The answer to whether you will owe state taxes because of student loan forgiveness could depend on where you live. That’s because there are reportedly at least thirteen states whose laws regarding the tax treatment of forgiven debt do not conform to the federal government’s current stance on student loan relief. As a result, it’s important to have information about those states, and to know what state tax liability for student loan relief could mean for you.
2022 Student Loan Forgiveness is Nontaxable
To understand whether student loan forgiveness will trigger an unexpected state tax bill, it helps to know why student loan forgiveness isn’t taxable at the federal level right now.
In 2021, during the COVID-19 pandemic, the American Rescue Plan Act (ARPA) became law, and effectively made student loan forgiveness nontaxable, for federal income tax purposes, through 2025. That’s a change from the general rule that you may have known from the past—i.e., that the IRS typically considers forgiven debt to be taxable for federal income tax purposes.
Also, when the Biden administration announced the 2022 student loan forgiveness on August 24, the White House confirmed that student loan relief under the program won’t be taxable to you as income on your federal tax return.
13 States That Could Tax Student Loan Forgiveness
While you won’t be taxed at the federal level for student loan debt cancellation, the Tax Foundation has reported that there are thirteen states that could tax the amount of student loan forgiveness you receive. Those states include Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, and Mississippi. New York, Pennsylvania, South Carolina, Virginia, West Virginia, and Wisconsin round out the list.
The reason why these states might consider forgiven student loan debt to be taxable income has to do with a concept called conformity. Basically, when the federal government enacts laws—in this case, laws that impact the Internal Revenue Code—many states readily conform relevant statues, rules, and regulations to the new federal tax treatment.
But there are other states whose existing statutes do not conform to the federal tax treatment in ARPA. And because broad student loan relief was just announced, those states may not have time (before some borrowers receive student loan forgiveness), to enact conforming legislation.
So, what does that mean for you? Well, the Tax Foundation’s analysis shows that tax liability for student loan forgiveness in those states could range from a little over $300 to as much as $1,100. So, if you live in Virginia for example, the maximum amount of state tax liability would be $575. However, that calculation assumes that you are eligible for the full $10,000 of loan forgiveness for individuals with income under $125,000 a year.
Hawaii residents, as another example, would have a relatively high state tax liability for student loan debt cancellation. Those borrowers could be taxed as much as $1,100 on $10,000 of student loan relief according to the Tax Foundation. And if you are a Pell Grant recipient in one of these states, and are eligible for up to $20,000 in student loan relief under President Biden’s plan, your state tax liability could be higher.
While this doesn’t seem like good news right now, it should be noted that it’s not certain that student loan forgiveness will be taxed in these states. Any, or all, of the thirteen states could possibly find a timely legislative way to exclude student loan forgiveness from taxable income.
What Should You Do?
At this point, there’s a lot of guidance that needs to be issued on how student loan forgiveness will work. That will be important at both federal and state levels. But if you live in one of the nine states that have no income taxes, you don’t have to worry about student loan forgiveness being treated as income on your state tax return.
However, if you live in one of the thirteen states that could tax student loan forgiveness, you will want to stay tuned to any guidance or information that is made available on the issue. That guidance could help you know whether student loan debt relief will affect your state taxable income—or your next tax bill.
For more information on student loan forgiveness and taxes, see Up to $20,000 in Student Loan Cancellation is Here: But Will it Hurt Your Taxes? And to learn more about President Biden’s 2022 student loan debt cancellation plan, see Biden’s Student Loan Forgiveness: What it Means for You.