Some States Could Tax Student Loan Forgiveness

President Biden’s student loan debt forgiveness plan is on hold due to legal challenges. The U.S. Supreme Court will hear the case in February and a ruling isn't expected until June, when student loan payments are expected to resume.. But there's always another important tax question out there involving student loans: will you have to pay state taxes on your forgiven student loan debt?

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 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.

Is Student Loan Forgiveness Taxable?

To understand whether student loan forgiveness will trigger an unexpected state tax bill, it helps to know why certain student loan forgiveness isn’t taxable at the federal level.

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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, 2022, the White House confirmed that student loan relief under the program (which is currently on hold due to court challenges) 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 likely 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, California, 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. Those states may not have time (before some borrowers receive student loan forgiveness--if they do), to enact conforming legislation.

So, what does that mean for you? An initial analysis by the Tax Foundation showed that tax liability for student loan forgiveness in various states could range 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 based on that analysis would be around $500. However, that calculation assumed 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, it should be noted that some of the states could find a timely legislative way to exclude student loan forgiveness from taxable income. Other states, like California, have indicated in the past, that forgiven student loan debt is "generally taxable." 

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 in 2022, that forgiven student debt provided by President Biden's student loan debt relief plan wouldn't be taxed as income for Hawaii income tax purposes. Pennsylvania made a similar announcement that student loan forgiveness won't be taxed in Pennsylvania.

What Should You Do?

At this point, you can stay tuned to information on the status of student loan forgiveness. And if you live in one of the nine states that have no income taxes, you don’t have to worry about student loan forgiveness (if the program is allowed to go forward) 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 and the forgiveness program ends up moving forward, you will want to stay tuned to any guidance or information that is made available on the issue. 

For example, in the past, the Department of Education said that some borrowers could opt out of student loan debt relief. That and other guidance, which could change in what is an evolving situation, could help you know how student loan debt relief =, if approved, will affect your state taxable income—or your next tax bill.