President Biden's announcement in August of up to $20,000 in broad federal student debt forgiveness likely came as a relief for millions of eligible borrowers, but it also brought with it plenty of questions. Fortunately, the White House later issued a press relief that answered many of these queries, including confirming that this debt relief won't be subject to the federal income tax. However, whether or not it will be considered income for state income tax purposes is still less certain. While some states, such as New York, have already assured residents their student debt forgiveness won't be taxed, this week California became the first state to confirm the opposite.
Here's what to know.
- According to the Tax Foundation, California has confirmed it will be treating Biden's student debt forgiveness as income for state tax purposes.
- Although the American Rescue Plan Act exempts canceled student debt from federal income taxes, state income taxes could still be levied.
- Per the Tax Foundation's analysis, the following six states may also tax discharged student loans: Arkansas, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin.
Student Debt Relief & Income Taxes
Generally speaking, any taxable amount of forgiven or discharged debt is treated as ordinary income and is therefore subject to federal and (potentially) state income taxes, per Internal Revenue Service (IRS) requirements. While the American Rescue Plan Act exempts certain discharged federal, private, or educational student loans from federal income taxes until Sept 30, 2025, state governments are still able make their own decisions on how to treat forgiven debt.
Most states either don't levy a state income tax at all or have already passed laws that at least somewhat follow the federal treatment of student loan relief. However, there is a small number of state governments who are currently on track to levy their respective income tax on the canceled educational debt.
What makes California's decision somewhat surprising is that even though its existing statutes indicate taxability for student loan forgiveness, state consensus previously ran in the opposite direction. Nevertheless, according to the Tax Foundation, it has confirmed that discharged student loan debt will be taxed under current California law. Additionally, existing state provisions exempting student loans that were canceled as part of income-based repayment programs won't apply.
Which States May Follow California's Lead?
According to the Tax Foundation's analysis, the following six states are currently on track to also tax student loan forgiveness: Arkansas, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin. The Tax Foundation's list previously included Massachusetts, but it has since been replaced by the Hoosier State.
Note that, unlike California, it isn't guaranteed that these six states will actually treat student loan relief as taxable income. Should state officials take action to change existing legislature, then the final count could be even smaller by the time borrowers receive their student debt forgiveness.
The Tax Foundation expects other states will issue guidance in the coming months on how canceled student debt will be treated. Given that California's decision was somewhat unexpected, residents of any state without confirmed tax treatment for Biden's student loans forgiveness would do well to periodically check with their respective state tax agency for any new announcements.