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Forgiven Student Debt Could Be Taxed in Some States

Posted on Aug. 26, 2022

The Biden administration has announced its long-awaited plan to forgive federal student debt up to $20,000, but there is some confusion regarding whether the plan would create state income tax liabilities.

Under the plan announced August 24, student loan debt up to $20,000 for federal Pell Grant recipients and up to $10,000 for other borrowers would be forgiven for individuals earning less than $125,000 and married couples earning less than $250,000. A provision in the American Rescue Plan Act excludes canceled debt from a taxpayer’s gross income if the loan is forgiven between December 31, 2020, and January 1, 2026, regardless of the reason the debt was discharged, which the White House said will apply to Biden's plan.

In a series of tweets August 24, Jared Walczak of the Tax Foundation said taxpayers in states with selective or outdated conformity or states that have not conformed to that ARPA provision could be required to include loan forgiveness amounts in their taxable income.

Some 17 states could fall under that category, including “some states that might go their own way entirely” by considering the forgiven debt through Biden’s plan to be taxable like any other canceled loan, Walczak told Tax Notes August 24. That could pose a problem for recipients of student loan forgiveness in those states, he said. “They may not immediately realize they have a tax liability in their state,” he added. In an August 25 blog post, Walczak reduced the number of states to 13, which he said is a preliminary count. 

Walczak included Virginia on his list of states that could tax forgiven student loans, but Monique Valentine Ford of Monique Valentine Ford CPA and the Virginia Society of CPAs told Tax Notes that the state tax code conforms to the ARPA provision excluding student loan forgiveness from taxable income. She cited a February 23 tax bulletin from the Virginia Department of Taxation, which indicates that the state conforms to several ARPA provisions, including the act's loan forgiveness exclusion for tax years 2021 through 2025. “The recent announcement would fall under that provision,” Ford said, but she also noted that there are "a lot of details still to be worked out." 

The Virginia Department of Taxation was unable to provide a comment by press time.

The Illinois Department of Revenue was similarly cautious, with spokesperson Maura Kownacki telling Tax Notes August 24 that the department will wait on the IRS’s instruction on the federal loan forgiveness plan. “Generally speaking, any type of loan forgiveness is considered taxable income to the debtor,” Kownacki said. “The White House announcement indicated that this loan cancellation would not be taxable income due to the ARPA.”

“The Illinois Department of Revenue (IDOR) will have to wait for the IRS to make a determination, and whatever the IRS decides, IDOR will take the same course of action,” Kownacki said.

Illinois is a rolling conformity state, which means it automatically conforms to the federal tax code unless the legislature amends the state code to decouple from a federal tax provision. Given that conformity, Dan Rahill, managing director of Wintrust Wealth Management and a member of the Illinois CPA Society, told Tax Notes that he doesn’t expect the state to include student loan forgiveness in taxable income.

“Our income tax calculation starts with federal adjusted gross income, which would not include the $10,000 of cancellation of indebtedness income based on the [federal] exemption,” Rahill told Tax Notes August 24. He added that although the legislature could decide to tax the forgiven debt, he doubts that would happen.

IRC conformity in Minnesota is done manually by the Legislature. Ryan Brown, media coordinator with the Minnesota DOR, told Tax Notes August 25 that the ARPA provision on student loan forgiveness was in the tax bill pushed by Gov. Tim Walz (DFL), which was not approved by the Legislature. “Since that was not passed, Minnesota is currently out of conformity with federal law in that area,” Brown said. “If the state does not conform to this federal law, then Minnesota taxpayers who have their student debt discharged will have to add back this amount for Minnesota income tax purposes.” He added that lawmakers could decide to pass conformity legislation but noted that the next legislative session isn’t scheduled to begin until early 2023.

And in Massachusetts, DOR guidance released January 12 said it "adopts ARPA's changes to Code section 108(f)(5), and income from the discharge of student loans excluded by ARPA may also be excluded from Massachusetts gross income.” Given that guidance, David M. Desmarais, a partner with Kahn, Litwin, Renza and a member of the Massachusetts Society of CPAs, said he believes it’s likely the state will provide an exclusion for forgiven loan amounts.

Walczak told Tax Notes that he expects states to release additional guidance and instruction for the loan forgiveness provision once they get closer to filing season.

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