President Biden’s announcement of student loan debt forgiveness is already raising many questions. How much will it cost? Who will benefit the most? How will it contribute to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. ? Does the president even have the legal authority to implement this loan forgiveness?
Here’s one more question to add to the mix: will states consider student loan forgiveness a taxable event? In some states, the answer could be yes.
As a general rule, a discharge of indebtedness counts as income and is taxable, as my colleague Will McBride explains. Under § 9675 of the American Rescue Plan Act (ARPA), however, the forgiveness of student loan debt between 2021 and 2025 does not count toward federal taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . States which follow the federal treatment here will likewise exclude debt forgiveness from their own state income tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s. But, for a variety of reasons, not every state does that. There are at least six relevant interactions with the Internal Revenue Code (IRC) for purposes of the treatment of student loan debt cancellation. States could:
- Conform to the current version of the IRC with ARPA (exempt)
- Conform to the current version of the IRC but decouple from ARPA (taxable)
- Not fully conform to the current IRC but bring in the relevant ARPA provision (exempt)
- Not fully conform to the current IRC but separately exclude student debt cancellation (exempt)
- Conform to a pre-ARPA version of the IRC (taxable)
- Selectively conform to the IRC or adopt independent definition of income (taxable)
Last Friday, we provided a list of states with the potential to taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. student loan debt forgiveness. This is an evolving issue because some state laws are expansive enough to provide administrative authority to exclude student loan debt discharge if so desired, or for state officials to announce that they believe they have the authority to do so under provisions of existing law, particularly those pertaining to the discharge of student debt in narrower existing circumstances.
Additionally, an earlier version of this post relied on slightly out-of-date conformity data which missed some of the final enactments of the 2022 legislative session, and thus erroneously indicated that a few states could have the potential to tax student loan debt forgiveness when, in fact, enactments within the past few months address that issue. Finally, of the states which still have the potential to tax student loan debt forgiveness, it is entirely possible that more may act administratively or legislatively before tax returns are due.
The following shows a smaller list of states that, after pronouncements from state officials, still appear to be on track to tax student loan debt forgiveness.
Arkansas. One of a handful of states which does not conform to the Internal Revenue Code in any significant way, Arkansas’s tax code is silent on the treatment of student loan debt forgiveness, and the ordinary rule—that a discharge of indebtedness constitutes taxable income—should prevail absent state action.
California. Previously noted here as a state where statutes seemed to indicate taxability but where the state consensus ran in the other direction, California has now confirmed that it will, in fact, tax student loan debt discharge under current law. The state’s conformity date is January 1, 2015, and provisions of an existing law exempting student loans canceled pursuant to income-based repayment programs will not apply.
Indiana. Although Indiana has a post-ARPA conformity date, the state statutorily decouples from IRC § 108(f)(5), which contains the exemption of forgiven student loan debt.
Minnesota. Minnesota’s conformity date is December 31, 2018, which is well prior to ARPA, and the state currently lacks any other provision to exclude student loan debt cancellation from income.
Mississippi. Another state which largely goes its own way in defining its tax base, Mississippi retains the ordinary treatment of discharged debt and is in line to tax student loan debt forgiveness.
North Carolina. Although North Carolina conforms to a post-ARPA version of the Internal Revenue Code, its conformity statute contains an add-back which taxes student loan debt forgiveness despite the federal change.
Wisconsin. With a conformity date of December 31, 2020, Wisconsin is currently in line to tax student loan debt forgiveness.
In several other states, tax officials have indicated that there will be no tax on student loan debt discharge despite ambiguity in state law. California, previously on this list, is now understood to tax student loan debt cancelation and is included above. Meanwhile in Pennsylvania, officials have announced that the Biden administration’s cancellation of student loan debt is not taxable, though the rationale for this determination is unclear. Pennsylvania has eight classes of taxable income, and historically, debt forgiveness—including student loan debt forgiveness—has been understood as fitting within existing classes.
Late last year, the Commonwealth issued a bulletin stipulating that while cancellation of student loan debt can ordinarily be taxable income, it would not be taxed if it was forgiven as part of several specific federal programs for individuals serving as teachers, firefighters, or nurses. Pennsylvania is now indicating that it will not tax this new broader class of debt forgiveness, and thus it has come off our list, though the authority for this change is not immediately clear. This is, however, the policy that we have chosen to follow here, and it’s one of the reasons why the new list is shorter.
Note that, while the debt—if retained—would have been paid over a period of years, the debt cancellation is included in income in the year in which it is taxed.
In the coming weeks and months, we are likely to see additional states issue guidance on the treatment of discharged student loan debt, and perhaps even adopt legislative fixes, causing this list to dwindle further.
To that point, analysis should never be construed as tax advice, but that is particularly true here. While this represents my best interpretation of how states are likely to treat student loan debt as of the date of publication, this list should not be relied upon for tax purposes. Absent direct state guidance on the treatment of student loan debt relief, affected taxpayers should consult with a tax preparer.
Note: Originally published on August 25th, this article was updated on August 30th and September 7th to address recent state administrative determinations and correct errors in the preliminary analysis of states with the potential to tax student loan debt forgiveness.