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13 states may hit borrowers with state tax liability on forgiven student loans

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President Joe Biden’s student loan forgiveness plan will soon cancel debt for thousands and thousands of Americans — and the relief is tax-free on federal returns. Nonetheless, experts say the cancellation should still trigger a state tax bill.

Most borrowers making lower than $125,000 per 12 months or $250,000 for married couples filing together will qualify for $10,000 of forgiveness, with as much as $20,000 of cancellation for Pell Grant recipients. 

Nonetheless, some states may count the canceled debt as income, explained Jared Walczak, vice chairman of state projects on the Tax Foundation.

More from Personal Finance:
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This may increasingly affect borrowers in greater than a dozen states, adding a maximum state liability of roughly $300 to $1,100, in keeping with Walczak, based on a preliminary evaluation from the organization.

These states may include Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, Recent York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin, the evaluation shows. 

‘Patchwork of approaches’ for state taxes

The American Rescue Plan of 2021 made student loan forgiveness federally tax-free through 2025, and the law covers Biden’s forgiveness, too, in keeping with the White House.

“Generally speaking, states use the federal tax code as a baseline for the way they define taxability,” said Walczak, explaining how some use what’s generally known as “conformity” to follow certain federal laws. 

Some states have “rolling conformity,” updating state tax laws as federal laws change, and others may only conform from a certain date, which can require updates to match the present law, he said.

There are a patchwork of approaches, most of which never really about student loan debt.

Jared Walczak

Vice chairman of state projects on the Tax Foundation

In some cases, states may “decouple” from certain federal provisions to make the state tax code its own, Walczak said.  

Since canceled debt is mostly taxable, “there are a patchwork of approaches, most of which weren’t ever really about student loan debt,” he said. 

State tax treatment of forgiveness may change

While the preliminary evaluation shows some states may tax student loan forgiveness, there’s still time for policy changes, Walczak said.

“States could come back very early in the following legislative session, update their conformity statute and make it effective immediately,” he said. 

And even though it’s “clear cut” in some states, others may depend on administrative guidance or a regulatory ruling, Walczak said. 

Should you’re unsure, it is best to talk with a neighborhood tax skilled and look ahead to guidance out of your state, he suggested.   

“This is just not a distinct segment issue that only affects just a few people,” Walczak said. “It affects a really large number of individuals and hopefully, there might be clarity provided on it.”

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