Most borrowers earning less than $125,000 a year, or $250,000 for married couples filing jointly, will qualify for $10,000 in forgiveness, with up to $20,000 waived for Pell Grant recipients. However, some states may count the canceled debt as income, explained Jared Walczak, vice president of state projects at the Tax Foundation. More from Personal Finance: What Biden’s Student Loan Forgiveness Means for Your Taxes Are your student loans eligible for federal forgiveness? How to check if you qualify for $20,000 in student debt relief That could affect borrowers in more than a dozen states, adding a maximum state liability of about $300 to $1,100, according to Walczak, based on a preliminary analysis by the agency. Those states may include Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin, the analysis.
“Matching Approaches” to State Taxes
The 2021 American Rescue Plan made student loan forgiveness federally tax-free until 2025, and the law also covers Biden’s pardon, according to the White House.
“Generally speaking, states use the federal tax code as a basis for how they define taxation,” Walczak said, explaining how some use what’s known as “compliance” to follow certain federal laws.
Some states have “rolling compliance,” updating state tax laws as federal laws change, and others may only comply as of a certain date, which may require updates to match current law, he said.
There is a patchwork of approaches, most of which never address student loan debt.
Jared Walczak
Vice President of Government Projects at the Tax Foundation
In some cases, states can “opt out” of certain federal provisions to make the state’s tax code its own, Walczak said.
Since canceled debt is generally taxable, “there’s a patchwork of approaches, most of which have never really been about student loan debt,” he said.
The tax treatment of forgiveness may change
While preliminary analysis shows some states may tax student loan forgiveness, there is still time for policy changes, Walczak said.
“States could come back very early in the next legislative session, update their compliance statutes and put them into effect right away,” he said.
And while it’s “clear-cut” in some states, others may rely on administrative guidance or regulatory ruling, Walczak said.
If you’re not sure, it’s best to talk to a local tax professional and follow the guidance from your state, he suggested.
“This is not a niche issue that only affects a few people,” Walczak said. “It affects a very large number of people and hopefully there will be clarity on that.”
