13 States Might Tax Forgiven Student Loans; See If Yours Is Among Them

Tom Ozimek
By Tom Ozimek
August 27, 2022Business News
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13 States Might Tax Forgiven Student Loans; See If Yours Is Among Them
Current federal tax forms are distributed at the offices of the Internal Revenue Service in Chicago, Ill., on Nov. 1, 2005. (Scott Olson/Getty Images)

President Joe Biden’s student loan forgiveness program has sparked a flurry of questions, including its impact on inflation and whether it’s fair to saddle some taxpayers with the burden of paying off others’ debts. Now the Tax Foundation has raised another—will it trigger tax liabilities for beneficiaries of the scheme?

Taxpayers will absorb up to $10,000 in outstanding student debt for individual borrowers earning less than $125,000 per year or $250,000 for married joint filers under Biden’s plan, with the amount forgiven doubling to $20,000 for Pell Grant recipients.

While the debt wipeout is free of federal taxes, some states have laws that treat the canceled debt as taxable income, according to Jared Walczak, vice president of state projects at the Tax Foundation.

“Here’s one more question to add to the mix: will states consider student loan debt forgiveness a taxable event? In many states, the answer could be yes,” Walczak said in a note.

13 States Might Tax Discharged Student Debt

Walczak explained that, in general, canceling student debt is taxable because it counts as income. However, the American Rescue Plan Act (ARPA) stipulates that forgiven student loan debt is excluded from federal taxable income through 2025.

Many states follow the federal treatment of student debt discharge but some do not, he pointed out. Whether or not discharged student debt is taxed or exempt at the state level is based on how state laws interact with the Internal Revenue Code (IRC).

Some states conform to the IRC with ARPA or don’t fully conform to the IRC but adopt certain provisions of the ARPA that make forgiven student loans tax-exempt.

But some states conform to the IRC but decouple from ARPA. Others selectively conform to the IRC or have their own definition of income. In such cases, student debt discharge is taxable.

The Tax Foundation estimates that there are 13 states which could impose a tax on discharged student debt, though they may take steps to make it exempt.

“Preliminarily, it appears that 13 states have the potential to tax discharged student loan debt, though the final count could be significantly smaller if states make legislative changes or administratively determine that the debt forgiveness can be excluded, or if conformity dates are updated retroactively,” Walczak said.

The following states have the potential to impose state-level taxes on discharged student loan debt: Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia, and Wisconsin.

The highest such tax liability, assuming $10,000 in forgiven student debt, falls in Hawaii ($1,100) while the lowest is in Pennsylvania ($307), according to the Tax Foundation analysis.

The others fall somewhere in between, with $700 levied in South Carolina and $500 in Kentucky, Massachusetts, and Mississippi, for instance.

What Cost to Taxpayers?

Walczak said it’s likely that some of these states will issue guidance on how they’ll treat discharged student debt from the perspective of taxation.

One thing to note, Walczak added, is that the potential state-level tax liability for the canceled student debt would have to be paid in the year when it’s taxed as an added part of income. If the debt is retained, however, it would normally be paid off over a period of years.

According to one analysis, Biden’s student loan forgiveness program is projected to cost taxpayers around $300 billion, economists at the Penn Wharton Budget Model estimated. The analysis also shows about 70 percent of debt relief accrues to borrowers in the top 60 percent of the income distribution.

A separate calculation from the Committee for a Responsible Federal Budget said it would cost more, between $440 billion and $600 billion over the next 10 years, with a central estimate of around $500 billion.

Biden said in a series of posts on Twitter that the forgiveness scheme will give working and middle-class families “breathing room” as they look to resume federal student loan payments.

Republicans have panned Biden’s debt wipeout as unfair to people who sacrificed to pay off their student loans or never racked them up in the first place but now have to foot the bill for other people’s debts.

“President Biden’s student loan socialism is a slap in the face to every family who sacrificed to save for college, every graduate who paid their debt, and every American who chose a certain career path or volunteered to serve in our Armed Forces in order to avoid taking on debt,” Senate Minority Leader Mitch McConnell (R-Ky.) said in a Wednesday statement.

“This policy is astonishingly unfair,” he continued, adding that Americans with outstanding student loans tend to earn more on average and lower-earning individuals would be saddled with the bill.

Rita Li contributed to this report.

From The Epoch Times

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