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13 states can hit borrowers with state tax liability on forgiven student loans

President Joe Biden’s student loan forgiveness plan will soon cancel debt for millions of Americans — and the relief is tax-free on federal returns. However, experts say the repeal could still trigger a state tax bill.

Most borrowers making less than $125,000 per year or $250,000 for married couples filing jointly will qualify for $10,000 in forgiveness, with a waiver of up to $20,000 for Pell Grant recipients.

However, some states may count canceled debts as income, explained Jared Walczak, vice president of state projects at the Tax Foundation.

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That could affect borrowers in more than a dozen states, adding a maximum state liability of about $300 to $1,100, according to Walczak. Preliminary analysis from the organization

Those states could include Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin, the analysis shows.

‘Patchwork of Approaches’ to State Taxation

The American Rescue Plan for 2021 has been developed Student loan forgiveness is federally tax-free through 2025, and the law also covers Biden’s forgiveness The White House.

“Generally speaking, states use the federal tax code as a baseline for how they define taxability,” Walczak said, explaining how some use what’s known as “compliance” to follow certain federal laws.

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

There is a patchwork of approaches, most of which are really about student loan debt.

Jared Walczak

Vice President of State Projects at the Tax Foundation

In some cases, states can “double down” from certain federal provisions to make the state tax code their own, Walcak said.

Because canceled debt is generally taxable, “there’s a patchwork of approaches, most of which weren’t really about student loan debt,” he said.

State tax treatment of forgiveness may vary

Although preliminary analysis shows that some states may offer student loan forgiveness, there is still time for policy changes, Walczak said.

“States can come back very early in the next legislative session, update their harmonized laws and immediately implement them,” he said.

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

If you’re unsure, it’s best to talk to a local tax professional and keep an eye out for your state’s guidance, he advises.

“This is not a niche problem that only affects a few,” Walcak said. “It affects a very large number of people and hopefully, there will be clarity.”

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