Thirteen states may tax canceled student loans

Borrowers in thirteen states who have student debt canceled under the Biden administration's plan may still be taxed hundreds of dollars next year on their forgiven loans.

President Joe Biden announced major reforms to student debt last week, including how borrowers making less than $125,000 a year (or up to $250,000 as a family) may have up to $20,000 in loans canceled for Pell Grant recipients and up to $10,000 forgiven if they did not receive a Pell Grant.

Thirteen states, including New York and Virginia, treat forgiven debt as income, which means it is subject to state taxes. This means borrowers who have their student loans forgiven may end up owing hundreds of dollars, according to an analysis published Thursday by the Tax Foundation, a nonprofit policy organization. 

The Tax Foundation's Vice President of State Projects Jared Walczak said that the maximum likely tax liability would double for those who have $20,000 in debt forgiven. For two states — New York and Wisconsin — Walczak's analysis did not include the rare case in which the maximum tax amount would change for someone who may qualify for loan forgiveness based on 2020 earnings only to enter the top-income bracket this year.

According to the White House, more than 60% of borrowers are Pell Grant recipients, which means they will have to pay the higher tax rate.

The federal government normally treats the discharge of indebtedness as taxable income, but under last year's American Rescue Plan Act, forgiven student loans will not count as federal taxable income until 2025. 

Walczak noted that his analysis "should never be construed as tax advice," as states have yet to issue direct guidance on how to treat student debt relief.