Student Debt Forgiveness May Be Taxable in More Than a Dozen States

(Bloomberg Law) — The billions in student loan debt forgiveness announced by the Biden Administration will be exempt from federal taxation but could be taxable at the state level in more than a dozen states—a hiccup many states are expected to quickly handle.

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Legislatures and state revenue departments are comparing their tax codes against President Joe Biden’s plan, announced Wednesday, to cancel $10,000 in student loan debt for those earning $125,000 or less and up to $20,000 in debt for Pell Grant recipients. While discharge of indebtedness is generally considered taxable income, the American Rescue Plan Act specified the forgiveness of student loan debt between 2021 and 2025 doesn’t count toward federal taxable income.

Those student loan provisions don’t flow down to state income tax returns in some states, however, depending on the way they adhere to the Internal Revenue Code, a concept known as “conformity,” said Jared Walczak, vice president of state projects at the Tax Foundation.

Walczak lists 13 states that haven’t fully conformed to the student loan debt provisions of ARPA, including Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia, and Wisconsin. He cautioned, however, that this is merely an interpretation of state discharge of indebtedness rules, and “taxpayers should consult with a tax preparer.”

Mark Kantrowitz, an authority on student lending and publisher of the website www.privateStudentLoans.guru, came up with his own analysis of state laws and puts the number of states where taxes would be imposed at 19.

Assuming $10,000 of debt is discharged for the 2022 tax year, Walczak said taxpayers could find themselves stung for between $500 and $1,100 in state taxes, depending on the rate in each state and other nuances in state tax codes.

Quick Action

Legislatures in the nonconforming states would have to act quickly if they want to spare their residents from taxes on the cancellation of student loan debt for the 2022 tax year—a tall order since most legislatures have adjourned for the year.

“The states would have to pass laws to affirmatively exclude it,” Kantrowitz said. “I’m not sure any of them would do anything. Even in the best of times, it takes the states a while to pass something. For them to pass laws in the next four months doesn’t seem likely.”

Pressure to conform to the federal code will be particularly intense in blue states, including Hawaii, Massachusetts, Pennsylvania, and New York, Kantrowitz said.

John Buhl, a senior communications manager at the Tax Policy Center, anticipates most if not all states will pursue the non-taxable route, especially since they’re sitting on strong revenues now.

“There’s going to be a lot of pressure on these states to follow the federal government’s treatment and not have this be included in taxable income because people don’t like surprises at the end of the year,” he said.

Walczak said lawmakers convening early next year still could pass laws conforming their tax codes to ARPA for the 2022 tax year. States already conforming to the federal to ARPA, he noted, might take action to decouple if they fundamentally disagree with the Biden Administration’s cancellation of debt policy.

“Conformity issues could still be taken up in the next legislative session,” Walczak said. “It’s a narrow window, but it’s possible. There may be ways in some states to pick it up administratively. Of course this is a separate consideration from whether student loan debt should be discharged.”

To contact the reporters on this story: Michael J. Bologna in Chicago at [email protected]; Erin Slowey in Washington at [email protected]

To contact the editors responsible for this story: Jeff Harrington at [email protected]; Butch Maier at [email protected]

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Source: https://finance.yahoo.com/news/student-debt-forgiveness-may-taxable-185647849.html