Is Student Loan Forgiveness Taxable?

President Biden’s recent student loan forgiveness actions are a win for many borrowers. However, as the relief gets closer, many are left wondering whether the discharged debt will be considered taxable income.

This isn’t a new concept. In fact, discharged indebtedness has been classified as taxable income for years. However, the unprecedented nature of broad loan forgiveness may warrant some exceptions to the rules.

If you’re left asking, “Is student loan forgiveness taxable?,” here’s what we know so far.

Will The Student Loan Forgiveness Be Taxed?

Section 9675 of the American Rescue Plan states that student loan forgiveness granted between 2021 and 2025 will not be considered taxable income at the federal level. However, it may be subject to state income tax depending on which state you live in.

States that mirror federal income tax guidelines will likely exclude student debt forgiveness from state income tax. However, other states may maintain their current tax code, making debt forgiveness taxable.

Which States Will Tax the Student Loan Forgiveness?

In the last few weeks, several states have instituted a temporary exemption in their tax rules for discharged debt. Given that other states may follow suit, it isn’t entirely clear which states will ultimately tax student loan forgiveness. However, based on current tax rules, there are predictions:

Arkansas. Under its current tax code, this southern state doesn’t allow tax exemptions for discharged student loan debt. Thus, if you live in Arkansas, your forgiven student loan debt will be subject to state income tax.

Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin are also expected to tax student loan forgiveness and have not said otherwise (as of yet).

Some states, such as California, previously had rules in place to classify discharged debt as taxable income but are implementing changes. According to a recent Twitter post from Anthony Rendon, California Assembly Speaker for District 63, California is awaiting finalized details from the federal government to better understand if “relief is tax exempt under current California law.” If not, the state will be instituting a temporary change to state law to make it exempt from state income tax.

Massachusetts has followed suit, announcing that student loan forgiveness will not be taxable in the bay state. Pennsylvania and New York have made similar announcements.

How Much Will I Be Taxed?

The exact amount you may be taxed depends on a variety of factors, such as your income and tax bracket, state income tax level, and any exemptions you’re eligible for. Based on some estimates, however, your tax liability could range from a couple hundred to a thousand dollars.

When Will I Be Taxed?

Even if you planned to pay your federal loan debt off over a certain period of time, the debt cancellation will be taxed the year it was forgiven. For example, if you have $10,000 in federal student loan debt and planned to pay it off over a 10-year repayment period, it will still be taxed in 2022 once forgiven.

Given the unexpected nature of this tax, it’s crucial to prepare for what you may owe come tax season.

Is Student Loan Forgiveness Usually Taxed?

Taxing student loan forgiveness isn’t entirely new. In fact, some established debt forgiveness programs, such as Income-Driven Repayment (IDR) Forgiveness, are taxable at the federal level. This is because debt cancellation is considered income, and income is taxable.

Whether it’s taxed at the state level, however, depends on the state itself. For example, some states believe student loan forgiveness should be tax-exempt in certain situations. In fact, many states do not typically tax discharged debt for public servants who received forgiveness through Public Service Loan Forgiveness. However, they may tax discharged student debt in other instances, such as IDR Forgiveness.

Is There a Way to Avoid Being Taxed on Student Loan Forgiveness?

Not quite. When filing your 2022 taxes, you’ll need to report your gross income, which includes the amount of debt you had canceled within the tax year. Then, you will be subject to taxes on that total amount.

Final Thoughts from the Nest

While most states won’t be taxing student loan forgiveness, others are firm in their stance to do so. Others are still in limbo, crafting their official perspective on the issue.

If you are concerned about your potential tax liability due to student loan forgiveness, it’s best to contact a professional tax preparer. However, it’s important to recognize that this information is still new and changing frequently as states announce exemptions, so even the professionals might not have all the answers.

This article was last updated 1/31/2024. Information regarding the tax liability of student loan forgiveness recipients is changing quickly. This information is intended for educational purposes only and should not be taken as tax advice. Please consult your tax advisor for recommendations based on your unique circumstances.