In August 2022, the Biden Administration announced widespread student loan forgiveness for eligible borrowers.
Those earning less than $125,000 a year (or under $250,000, for those married filing jointly) could have up to $10,000 in federal student loan debt wiped out. That number doubles for Pell Grant recipients, who could receive up to $20,000 in debt forgiveness.
For many borrowers, student loan forgiveness lets them eliminate money stress from debt and focus on other goals, like building their careers or buying a home. For borrowers in some states, however, debt relief comes at a cost.
After the Biden Administration unveiled its student loan debt relief plan, several states declared that they would tax the forgiven debt. Minnesota was one such state.
Current Minnesota law conforms to previous federal definitions of taxable income — definitions that don’t exclude student debt relief from regular wages. That means Minnesotans who receive student loan forgiveness have to include that forgiveness as part of their income.
While many legislators in the North Star State are pushing to make this loan relief tax exempt, until the law changes, student loan borrowers in Minnesota could face a tax bill close to $2,000.
Indiana is yet another Midwest state that uses a now-outdated definition of taxable income. What’s interesting, though, is that the state did adopt current federal income definitions for some situations, but they made an exemption for student loan forgiveness.
With the state tax rate currently at 3.23%, debt forgiveness could come with a tax liability as high as $646.
The real kicker, though, is that some Indiana counties levy their own income tax. Not only might some Hoosiers get hit with a state tax bill, but they could also owe an additional several hundred dollars in local taxes, too.
America’s Heartland states aren’t alone in their plans to tax federal student loan relief. North Carolina is one of several southern states that intends to collect on residents’ forgiven debt.
Like Indiana, North Carolina elected not to adopt new Internal Revenue Code provisions that would exempt student debt forgiveness from taxation. Instead, North Carolina borrowers who have some or all of their student loans discharged could pay as much as $998 in state income taxes.
Thankfully, North Carolina’s flat income tax rate will decrease slightly in the coming years, dropping from 4.99% in 2022 to 4.75% in 2023. This will help to reduce the tax burden for North Carolinians who receive federal loan forgiveness, but only slightly.
Mississippi joins North Carolina in taxing student loan relief, for many of the same reasons. A key difference, however, is that Mississippi uses a graduated tax rate.
The state imposes a 0% tax rate on residents’ first $4,000 in income, 3% on their next $1,000, and so on. The highest possible tax rate is 5%, levied on income over $10,000. That means Mississippians will have to do a bit of extra math to see if and how federal debt forgiveness will impact their individual tax liability.
There is one possible saving grace, however: as of this writing, the Mississippi Department of Revenue hasn’t yet determined how they’ll track, or bill, residents’ discharged loans.
While a few states are committed to taxing federal student loan relief, others, like California, remain undecided.
In the Golden State, student debt forgiveness is only considered tax exempt under certain circumstances. Say, for example, that a person’s student loan balance is cleared after making enough payments under an income-based repayment plan. In this case, California considers loan discharge tax exempt.
This conditional tax exemption is why California’s Franchise Tax Board is still grappling with how to handle federal loan forgiveness. Whether that forgiveness is processed under federal income-based repayment provisions will ultimately determine how California moves forward with taxation.
Pro tip: Use these clever ways to pay off debt and accelerate your student loan repayment.
Typically, debt forgiveness of any type is taxable in Arkansas. When it comes to taxing federal student loan relief, however, the state is still in limbo.
Should the Arkansas legislature decide not to tax student debt forgiveness, it wouldn’t be the first time they cut their residents some slack. In March 2021, the state temporarily suspended taxes on unemployment benefits for the 2020 and 2021 tax years.
That said, Arkansas Governor Asa Hutchinson and Attorney General Leslie Rutledge are both vocal opponents of federal student loan relief.
For these reasons, it’s difficult to say how Arkansas might proceed with taxing student loan forgiveness. The pendulum could swing either way.
In Wisconsin, lawmakers haven’t yet updated the state tax code to reflect the recent student loan relief provisions. That doesn’t mean they won’t, though.
Just like in Arkansas, whether or not Wisconsin levies tax on federal loan forgiveness is still TBD. The Wisconsin state legislature convenes in January 2023, with current Governor Tony Evers poised to suggest amending the state tax code to prevent loan relief taxation.
While this might give student loan borrowers in Arkansas some hope, there’s no guarantee that Evers’ proposal will pan out. Not only is he up for reelection this year, he’ll also need to convince the Wisconsin legislature to approve the tax code changes.
What about the other states?
If you don’t reside in any of the states mentioned here, you’re probably wondering what to expect during the next tax-filing season. Depending on where you live, you may not have anything to worry about at all.
If you live in a state with no income tax or that conforms to the latest version of the federal tax code, you won’t owe anything on your student loan relief. But even if your state doesn’t conform, you may still be off the hook.
Several states that use older definitions of taxable income have committed to keeping student loan forgiveness tax-free, permitting residents to enjoy their debt reduction without worrying about tax liability on the back end.
Student loan forgiveness will help many borrowers inch closer to realizing the debt-free dream, but it’ll incur a tax liability for others.
If you live in a state where student debt relief is treated as income, consider starting your tax prep sooner rather than later. Strategizing your taxes is one of many ways to relieve financial stress, and it’s especially applicable here.
The earlier you know if and how much you’ll owe, the more time you’ll have to maximize your deductions. That means a smaller tax bill come filing season — and extra money in your pocket.
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