President Biden’s August announcement of up to $20,000 in federal student debt relief likely brought relief to millions of eligible borrowers, but it also raised many questions. Fortunately, the White House later issued a press release that answered many of these questions, including confirming that this debt relief will not be subject to federal income tax. However, whether or not it is considered income for state income tax purposes is even less certain. While some states, like New York, have already assured residents that their student loan forgiveness will not be taxed, California this week became the first state to confirm otherwise.
Here’s what you need to know.
Key points to remember
- According to the Tax Foundation, California has confirmed that it will treat Biden’s student debt forgiveness as income for state tax purposes.
- Although the American Rescue Plan Act exempts canceled student debt from federal income tax, state income tax may still be levied.
- According to the Tax Foundation’s analysis, the following six states can also tax paid-up student loans: Arkansas, Indiana, Minnesota, Mississippi, North Carolina and Wisconsin.
Student Debt Relief and Income Taxes
Generally, any taxable amount of canceled or discharged debt is treated as ordinary income and is therefore subject to federal and (potentially) state income tax in accordance with the requirements of the Internal Revenue Service (IRS). While the American Rescue Plan Act exempts certain federal, private, or educational loans discharged from federal income tax until September 30, 2025, state governments are still able to make their own decisions about how to deal with canceled debt.
Most states do not levy income tax at all or have already passed laws that at least somewhat follow the federal treatment of student loan relief. However, a small number of state governments are currently on track to levy their respective income tax on canceled education debt.
What makes California’s decision somewhat surprising is that even though its existing laws point to the imposition of student loan forgiveness, the state’s consensus was previously pointing in the opposite direction. Nonetheless, according to the Tax Foundation, it confirmed that the released student loan debt will be taxed under current California law. Additionally, existing state provisions exempting student loans that have been forgiven under income-tested repayment programs will not apply.
Which states could follow California’s lead?
According to the Tax Foundation’s analysis, the following six states are currently on track to also impose student loan relief: Arkansas, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin. . The Tax Foundation list previously included Massachusetts, but it has since been replaced by the state of Hoosier.
Note that, unlike California, these six states are not guaranteed to actually treat student loan relief as taxable income. If state officials move to change the existing legislature, the final tally could be even smaller by the time borrowers receive their student loan forgiveness.
The Tax Foundation expects other states to release guidelines in the coming months on how canceled student debt will be handled. Since California’s decision was somewhat unexpected, residents of any state without confirmed tax treatment for Biden’s student loan forgiveness would do well to periodically check with their respective state tax agency for any new announcements.