Those who have their federal student loan debt forgiven will not pay federal income tax on the cancellation, but some are finding that they could be facing a stiff state tax bill.
A handful of states have indicated that they may count the canceled debt as income and apply state taxes to it.
President Joe Biden announced the plan last week that would forgive up to $10,000 in federal student loan debt for people who make less than $125,000 per year, and up to $20,000 for borrowers who attended college using Pell Grants, loans designed to help low-income students.
In most cases, including student loan debt, the federal government considers forgiven or canceled debt to be taxable income, or income subject to tax, after deductions and exemptions are taken.
However, under the American Rescue Plan passed in 2021, federal student loan debt canceled between 2021 and 2025 cannot be counted as federal taxable income.
The American Rescue Plan does not affect a state’s decision on whether to tax the debt cancellation as income, and, so far, five states have indicated they will likely do just that.
According to Jared Walczak, vice president of state projects at the Tax Foundation, five states — Arkansas, Minnesota, Mississippi, North Carolina and Wisconsin — will likely consider canceled student debt as taxable income.
The Mississippi Department of Revenue confirmed to Bloomberg that canceled student loan debt will be subject to income taxes in the state.
“Taxpayers in these states just need to be aware that there is likely to be a tax hit associated with receiving this debt forgiveness.” Walczak told Time.
The Tax Foundation collects data and publishes research studies on U.S. tax policies at both the federal and state levels.
Only a few states have addressed the issue of making the debt cancellation subject to state taxes. In most states, the move would require legislatures to vote to conform with the federal tax policy that does not count debt cancellation as taxable income.
New York and Pennsylvania are among the states who have said that the student debt forgiveness plan Biden announced last week would not be taxed as income.
Hawaii, Idaho, Kentucky and Virginia have announced that they, too, will exempt student loan forgiveness money from state taxes, Bloomberg News reported Tuesday.
What does taxable income mean when it comes to student loan debt?
Say you make $35,000 a year in taxable income and had federal Pell Grant debt of $20,000 forgiven. Then instead of owing state taxes on $35,000 of taxable income, you would owe state taxes on $55,000 of taxable income.
How much would state taxes be?
According to the Tax Foundation, the tax bill for student loan forgiveness could range from around $300 to as much as $1,100, depending on which state you live in.
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