In August 2022, President Joe Biden announced a student loan forgiveness plan. The basics of the plan include up to $20,000 in student loan debt relief.
While the idea of student loan forgiveness received some positive press for President Biden, there could be some potential drawbacks in the form of taxes. Some states have said they will tax amounts forgiven under this debt cancellation plan.
Student loan forgiveness and taxes
The IRS considers most types of canceled debt as taxable income. You usually have to report the canceled debt as income on your tax return if you receive forgiveness.
In the past, student loan forgiveness has been taxable, depending on the program. For example, as part of income-driven repayment, student loan cancellation was treated as taxable income, similar to other types of canceled debt. Public Service Loan Forgiveness (PSLF), on the other hand, was implemented without the forgiven amount being taxed.
In general, taxpayers had to determine what types of loans they had. While some federal student loan forgiveness programs weren’t taxable, most private forgiven student loans are considered taxable income. You can check to see what types of loans you have and what repayment plan you have by going to StudentAid.gov.
You might have to report your student loan forgiveness on your tax return, which could mean a large tax bill depending on the situation.
The status of Biden’s student loan cancellation
Currently, President Biden’s student loan cancellation program is moving forward. The idea is to forgive up to $20,000 in student loans for Pell Grant recipients and up to $10,000 in student loans for other borrowers. However, to be eligible, borrowers must meet certain income guidelines and have federal student loans under the Direct loan program.
However, lawsuits against the loan forgiveness plan are already coming in. While some have been dismissed, others are still pending. States and other organizations are filing lawsuits in an attempt to stop student loan forgiveness.
There have been some modifications to the original student loan forgiveness announcement due to the lawsuits. For example, FFEL loans included in the original announcement had to have been consolidated into Direct loans by September 29, 2022, to be included in the current one-time debt cancellation program. Additionally, the White House limits Parent PLUS borrowers’ ability to get loan forgiveness.
The student debt forgiveness application is supposed to go live sometime in October 2022. The Biden Administration recommends that borrowers sign up for alerts from the Department of Education to receive information when the application goes live.
When is student loan forgiveness tax-free?
In the past, the tax code counted many types of student loan forgiveness as income subject to federal income tax. However, thanks to the American Rescue Plan, which Congress passed in 2021, federal student loan forgiveness can no longer be taxed (at least until the end of 2025), according to the internal revenue code.
Just because the tax treatment is favorable at the federal level, though, doesn’t mean that you’re in the clear. Some states are implementing tax policies to collect revenue from student loan debt forgiveness.
States where borrowers might be taxed for student loan cancellation
You might still be taxed on your canceled debt at the state level. The Tax Foundation keeps an updated list, so it’s important to take a look. Some states, like Pennsylvania, typically tax loan forgiveness amounts. However, that state announced that it will waive the taxes on the current program from the federal government.
Here are the states that currently appear on track to tax student loan borrowers that receive debt cancellation under Biden’s student loan forgiveness.
Arkansas generally views debt forgiveness as taxable income, making no distinction between student loan debt and other types of debt. As a result, unless the state makes an exemption, loan forgiveness is likely to be taxed at the state level.
California’s law doesn’t count debt cancellation from income-driven repayment plans as taxable income. However, in the case of the current loan forgiveness, California is not waiving the tax. As a result, Californians reporting on their state income tax forms will likely end up with a bigger tax bill.
Although Indiana generally conforms with the federal tax law in the American Rescue Plan Act (ARPA), student loans are excepted. As a result, those receiving Biden’s student loan forgiveness should prepare to pay state taxes.
While Minnesota generally conforms with federal tax laws, the reality is that its date was in 2018, before ARPA. Minnesota hasn’t updated its conformity to include student loan debt forgiveness. As a result, the state’s Department of Revenue will likely be collecting on cancellation amounts.
As with some other states, Mississippi goes its own way for tax purposes. All forgiven debt is considered taxable income — including student loan debt.
While North Carolina’s tax law conforms with ARPA policies, the state made a conscious decision to leave out student loan debt forgiveness. As a result, North Carolina is likely to tax loan cancellation received by its citizens.
Although a judge dismissed Wisconsin’s lawsuit against the Biden Administration’s debt forgiveness plan, the state is still planning to tax loan forgiveness.
How much tax will borrowers have to pay?
How much tax student loan borrowers pay on their forgiveness depends on state-level policies and tax brackets. In general, forgiven debt is added to income in the year it was forgiven. So, if you receive $10,000 in student loan forgiveness due to the Biden Administration’s plan, you will report an additional $10,000 of taxable income on your state tax return.
Depending on your state’s policies and your tax bracket, that could result in a bigger tax bill.
If you’re unsure have how to proceed with student loan debt forgiveness, you can schedule a consult with one of our professionals. Our Student Loan Planner® experts can help you review your options and develop a practical plan for tackling forgiveness, repayment and refinancing.