Student loan forgiveness may come with a state tax bomb
Although the American Rescue Plan Act of 2021 changed the federal tax treatment of the student loan forgiveness until December 31, 2025, making it tax-free, the student loan forgiveness may be taxable in up to 19 states. .
According to a review of state tax rules posted on the College Investor website, Student loan forgiveness tax-free in 31 states. This includes 11 states with no income tax and 20 states that automatically comply with changes to the Internal Revenue Code of 1986.
The student loan forgiveness may be taxable in the remaining 19 states. Some of these states comply with federal tax rules, using the federal definition of adjusted gross income (AGI) or taxable income, but only on a specific date. Others use their own definition of income. All of these states will need to pass laws to exclude student loan debt forgiveness from income.
Otherwise, the debt cancellation is treated as income for the borrower. It is as if someone is providing the borrower with money to pay off their debt.
These states already have a patchwork of laws that tax certain types of student loan forgiveness. For example, Pennsylvania taxes the public service loan rebate and the teacher loan rebate. Virginia excludes disability leave from income, but only for veterans. Virginia’s income exclusion for bereavement leave only applies to federal student loans, not private student loans or parent loans.
The rules for each state are also a bit hazy. Typically, states start with the federal definition of income, but change it through a long list of additions and subtractions. But the treatment of the forgiveness of student loans is not entirely clear. None of the states provide a list of taxable loan forgiveness types and those that are not. Even the state revenue code does not always provide clarity.