Recently, the Biden administration launched the application process for most student loan borrowers to have up to $20,000 of their education loans forgiven. While qualifying individuals can be assured the amount of debt forgiveness won’t be taxed on their federal tax returns, not all states have adopted the same treatment.
Under the American Rescue Plan Act (ARPA) that was passed in 2021, Congress outlined that any student loan debt forgiven between 2021 and 2025 will be exempt from federal income taxation. Fortunately, for most taxpayers, 35 states have conformed to the federal rules and will also not subject any loan forgiveness to income tax.
As it currently stands, there are six states that intend to tax the amount of forgiveness or have not announced plans to exempt it. Those states include Arkansas, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin. Here is a summary of each state’s position:
How does Arkansas treat student debt forgiveness?
- The Arkansas Department of Finance and Administration has issued a statement which stipulates debt forgiveness is generally taxable to the recipient. However, given that the state has conformed to other tax benefits throughout the pandemic, including the tax-exempt treatment of PPP loans, it’s uncertain whether the Department’s current position will hold.
How do Indiana, North Carolina, and Wisconsin treat student debt forgiveness?
- Indiana taxpayers who receive student loan forgiveness should expect to see an increase in their state income tax as a result. Indiana has deliberately decoupled from IRC § 108(f)(5), which may be interpreted as its position on the matter.
- North Carolina, similar to Indiana, has not adopted IRC § 108(f)(5). Therefore, absent any new legislation, student debt relief will be taxable.
- Wisconsin is also among the states which do not currently conform to IRC § 108(f)(5). The Wisconsin Department of Revenue has even published an entire FAQ page on its website instructing taxpayers on how to treat and report any amount of loan relief they receive.
- Similarly, Mississippi has publicly announced that it plans to treat forgiven debt as taxable income.
How does Minnesota treat student debt forgiveness?
Minnesota’s approach may seem confusing to many taxpayers within the state who receive student loan forgiveness. Ordinarily, the state has allowed taxpayers who had their student loans forgiven through existing programs such as the Pay As You Earn (PAYE) or Revised Pay As You Earn (REPAYE) to exclude the forgiveness from taxable income. However, the state has made a special announcement in regards to the Biden Administration’s Student Debt Relief Plan and claimed the amount of forgiveness through this program will be taxable in the state.
Taxpayers in any of these six states who receive student debt relief should be aware of the increase in their tax liability. In most cases, taxing debt forgiveness creates the same problem as phantom income, where taxpayers are treated as receiving income under the law, but there is no accompanying cash inflow to help pay the associated tax. Unassuming taxpayers may find themselves with an unexpected amount due when they file their returns next April.
Article by Jarrod Galassi, Senior Tax Manager
