13 states could hit borrowers with state tax liability on canceled student loans

President Joe Bidenit is student loan cancellation plan will soon cancel the debt of millions of Americans – and the relief is tax exempt on federal returns. However, experts say cancellation can still trigger a state tax bill.

Most borrowers earning less than $125,000 a year or $250,000 for married couples who file together will be eligible for $10,000 back, with up to $20,000 cancellation for Pell Grant Recipients.

However, some states may consider canceled debt as revenue, explained Jared Walczak, vice president of state projects at the Tax Foundation.

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This can affect borrowers in more than a dozen states, adding a maximum state liability of about $300 to $1,100, according to Walczak, based on a preliminary analysis organisation.

These states may include Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin, according to the ‘to analyse.

“Patchwork of Approaches” for State Taxes

The 2021 US bailout has made tax-free federal student loan forgiveness through 2025, and the law also covers Biden’s pardon, according to the White House.

“Generally, states use the federal tax code as a basis for defining taxation,” Walczak said, explaining how some use what’s called “compliance” to track certain federal laws.

Some states have “ongoing compliance,” updating state tax laws as federal laws change, and others can only comply from a certain date, which may require updates to match current law, he said.

There are a multitude of approaches, most of which never really address student loan debt.

Jared Walczak

Vice President of State Projects at the Tax Foundation

In some cases, states can “decouple” from certain federal provisions to appropriate the state tax code, Walczak said.

Since forgiven debt is generally taxable, “there are a multitude of approaches, most of which have never really focused on student loan debt,” he said.

The tax treatment of the state rebate may change

Although preliminary analysis shows some states may mandate student loan forgiveness, there’s still time to change policy, Walczak said.

“States could come back very early in the next legislative session, update their compliance status and make it effective immediately,” he said.

And while it’s “decided” in some states, others may rely on administrative guidance or a regulatory decision, Walczak said.

If you’re unsure, it’s best to speak with a local tax professional and watch your state’s advice, he suggested.

“It’s not a niche issue that only affects a few people,” Walczak said. “It affects a very large number of people and I hope there will be some clarification on this.”

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