Some States Will Tax Student Loan Forgiveness

You won’t pay federal income taxes on cancelled student loan debt through 2025, but there are some states that will or could tax your student loan forgiveness.

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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 will depend on where you live. That’s because there are reportedly some 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.

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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.

Will You Pay State Taxes on Your Forgiven Student Loan?

While you won’t be taxed at the federal level for student loan debt cancellation, there are some states that could or will tax the amount of student loan forgiveness you receive. Those states currently include Arkansas, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin.

The reason why some of 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, an initial analysis by the Tax Foundation showed that tax liability for student loan forgiveness in various states could've ranged from a little over $300 to as much as $1,100. So, if you live in Mississippi for example, the maximum amount of state tax liability would be $500. 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. And if you are a Pell Grant recipient in one of the states that could or will tax forgiven student loan debt, 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 with the exception of Indiana, Mississippi, and North Carolina, some of the states could find a timely legislative way to exclude student loan forgiveness from taxable income.

For example, Hawaii residents would have had a relatively high state tax liability for student loan debt cancellation. Those borrowers could have been taxed as much as $1,100 on $10,000 of student loan relief according to the Tax Foundation's initial analysis. But Hawaii's Department of Taxation announced on August 29, that forgiven student debt provided by President Biden's student loan debt relief plan won't be taxed as income for Hawaii income tax purposes. Governor Tom Wolf of Pennsylvania made a similar announcement on August 31—i.e., that student loan forgiveness won't be taxed in Pennsylvania.

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 states that could or will tax student loan forgiveness, you will want to stay tuned to any guidance or information that is made available on the issue. For example, recently the Department of Education said that some borrowers can opt out of student loan debt relief. That and other guidance, which is coming out quickly in what is an evolving situation, could help you know how 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.

Kelley R. Taylor
Tax Editor, Kiplinger.com