If you’re among the millions of Americans who are eligible for the sweeping student loan forgiveness, your relief may be short-lived if you’re worried about owing taxes on your canceled debt.
On Aug. 24, President Joe Biden announced plans to forgive up to $10,000 in federal student loan debt for individual borrowers who earn less than $125,000 a year ($250,000 for couples and heads of households). Up to $20,000 in forgiveness will be available to Pell Grant recipients.
Details of the new plan are still emerging. In the past, some discharged student loan amounts were considered taxable income, so borrowers may be wondering what the tax implications might be once this widespread relief becomes a reality.
Will you be stuck with a big tax bill?
The short answer is no — at least on your federal tax return. State taxes could be a different story.
Read on to learn more.
Will You Owe Taxes On Your Forgiven Student Debt?
For federal income tax purposes, no. The American Rescue Plan of 2021 made student loan forgiveness tax-free from Dec. 31, 2020, through Dec. 31, 2025.
Generally, when debts are forgiven, the forgiven amount still counts toward your taxable income, which can increase your bill at tax time.
In the past, for example, borrowers enrolled in an income-driven repayment plan could qualify for loan forgiveness after 20 or 25 years — but they still had to pay federal taxes on the amount wiped clean.
That’s not the case for borrowers who qualify for widespread forgiveness.
Those canceled student loans will not be treated as taxable income for federal income tax purposes, according to a fact sheet from the White House.
The same applies to the patchwork of other student loan forgiveness programs implemented by the White House since Dec. 31, 2020, including debt cancellation for people with permanent disabilities and those defrauded by certain schools, like ITT Tech.
You won’t need to report any forgiven federal student loan debt to the IRS next year. (Usually, you would need to fill out IRS Form 1099-C, which details the amount of canceled debts totaling more than $600.)
Will You Still Have To Pay State Taxes?
While the American Rescue Plan excludes student debt forgiveness from federal taxation, state taxes may still apply.
Some states already follow federal tax income guidelines.
“Most of the time, you start with federal taxable income to determine your state tax liability and work your way back from there,” said Robert Persichitte, a certified public accountant at Delagify Financial in Colorado.
But other states use their own definition of income.
Nine states don’t have state tax at all: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
Student loan forgiveness is tax-free in 19 other states and the District of Columbia because those states follow federal income guidelines, according to a review of state income tax rules by The College Investor.
Those 19 states are:
- New Mexico
- New York
- Rhode Island
That still leaves 22 states that may or may not tax forgiven student loan debt.
Unless these states make changes before the 2023 tax filing year, borrowers with forgiven student debt may face higher state income taxes.
“It’s unlikely those states would tax the income for revenue reasons — but they might for political reasons,” Persichitte said.
That uncertainty can be frustrating for borrowers. But Persichitte said it’s best to sit tight until more information is available.
“My advice is to keep an eye on the news and wait until we have details before making any life-changing decisions,” Persichitte said. “There’s a lot we don’t know yet.”
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.