Which States Tax Student Loan Forgiveness?

Student loan debt in the United States has exploded over the past two decades to more than $1.7 trillion in total. The average federal borrower has over $37,000 in student debt. So it’s good news when President Biden finally has announcement that his administration erase up to $20,000 in federal student loan debt.

The measure had been one of his campaign promises, but it took almost two years after his inauguration to develop full-scale debt cancellation. While financial relief for federal student loan borrowers will not be taxed thanks to the US bailout, this will not be the case in at least four states, with three more considering doing so.

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States That Will Mandate Student Loan Debt Forgiveness

Under the American Rescue Plan Act, cancellation of student loan debt between 2021 and 2025 does not count as federal taxable income. Not all states tax income, but the vast majority of states have taxable income that meets the federal definition of taxable income.

However, currently, Indiana, Minnesota, Mississippi and North Carolina will treat any canceled student loan amount as earned income. Three others are still deciding to do so at this time, including Arkansas, West Virginia and Wisconsin.

How much state tax will recipients of student loan debt forgiveness have to pay?

There are a handful of factors that will determine how much tax a borrower will have to pay for debt discharge. Recipients of debt forgiveness will have to add the amount they receive to their other sources of taxable income and see what tax bracket they are in for their state to determine the rate at which they will be taxed.

Analysis by the Tax Foundation, assuming you are eligible for $10,000 loan forgiveness, the maximum for those whose income is less than $125,000 per year, in Mississippi would have to pay $500 on this source of income. Double this amount for Pell Grant recipients who qualify for $20,000 in debt forgiveness.

Paying Tax on Student Loan Debt Cancellation Shouldn’t Deter Recipients

Depending on the state you live in, the income tax rate could be flat, like Indiana and North Carolina, so the extra income doesn’t put you in a higher tax bracket. However, Mississippi has a progressive rate where income starts at three percent for income over $4,000 and increases in increments to a maximum of five percent for taxable income over $10,000.

Income is also taxed progressively in Minnesota, as well as in Arkansas, West Virginia and Wisconsin. However, the additional amount of tax payable resulting from the forgiveness of federal student loans would be in most cases be more than offset by debt reduction.

“Even if you are taxed at a higher rate because you got an extra discount, which could potentially earn you a lifetime without having to worry about your student loan,” Jacob Channel, senior economist at LendingTree, said CNBC. “In most cases, the benefit you’ll get from forgiving $10-20,000 of your student loan debt will likely outweigh the tax burden.

Important Dates for Federal Student Loan Debt Cancellation

Those who qualify for student debt relief will need to keep four important dates in mind. Sometimes in October a simple application will be available and those who could see their student loan debt reduced to zero through debt forgiveness and who do not want to make further payments on their loan want to get it by November 15.

It’s because student loan moratorium ends December 31 and the Ministry of Education says it will take up to six weeks from the time the application is submitted until the debt is cleared. The deadline, December 31, 2023, will be the deadline for applying for federal student loan debt forgiveness.

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