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Do You Have to Pay Tax on Student Loan Forgiveness?

Do You Have to Pay Tax on Student Loan Forgiveness?

High Net Worth Families

Student loan forgiveness is getting substantial media attention, thanks to the Biden administration’s recent announcement that more than a half million borrowers will see their student debt balances wiped out automatically. This forgiveness cancels nearly $6 billion in federal student loans for 500,000+ former students of the now defunct Corinthian Colleges.

All the recent chatter about student loan forgiveness, along with the mention of several exceptions, has many student loan borrowers wondering whether loan forgiveness is taxable.

Why Is the American Rescue Plan Act Loan Forgiveness Provision Significant?

Typically, a forgiven loan — such as credit card debt, personal loans as well as most student loans — is taxable for federal purposes. In other words, the forgiven or canceled debt could be treated as income to the borrower for tax purposes. This scenario, particularly for students who took out large student loans, could result in a massive tax bill should those loans be forgiven.

The American Rescue Plan Act (ARPA), signed into law in March 2021, included a provision about student loan forgiveness, including a mechanism for the tax treatment of future loan forgiveness.

ARPA also brought about some carve outs that make private loan forgiveness possible. Certain federal student loan forgiveness programs, including the Public Service Loan Forgiveness program and the Teacher Loan Forgiveness program, aren’t taxable under current federal law.

Let’s dive into the taxation of student loan forgiveness at the federal and state levels.

Federal Taxation of Student Loan Forgiveness

Under IRC section 108(F) modified by ARPA, there is an exemption from federal tax on student loan forgiveness if:

  1. The loan was discharged in 2018, 2019 or 2020 due to a student’s death or total permanent disability.

  2. The loan is discharged between 2021 and 2025 for any reason. This provision was included in ARPA with the anticipation that a wider scale cancellation of student debt will be implemented under the Biden administration.

  3. The loan is discharged or cancelled in any tax year if the student works for a specific period in certain professions that need workers, such as teaching and healthcare, or with certain types of employers, such as federal agencies, public service and volunteer organizations like the Peace Corps.

  4. The student receives repayments of forgiveness of student loans as a participant in certain health programs or if the student’s school closes while attending or enrolled.

State Taxation of Student Loan Forgiveness

Most states, including Maryland, Virginia and Washington, DC, begin with federal income and then have additions and subtractions from the federal income depending on the specific state laws. Typically, when a federal provision like the one described above is enacted, the state does not conform with the federal change unless they specifically state that they will.

Currently, the only states that said they will conform with the student loan-related provisions of ARPA are Arizona, California, Georgia, Indiana, Maine and North Carolina.

Pennsylvania conforms with certain student loan forgiveness, but only if the loan was forgiven through the Public Service Loan Forgiveness program or the Pennsylvania Student Loan Relief for Nurses program. Otherwise, student loan forgiveness for Pennsylvania residents is taxable.

New York only excludes the discharge of student loan debt if it was due to the death or disability of the student.

What’s Next?

Until there is a broader passage of student loan forgiveness, I believe that most states will not address this issue, and therefore, forgiveness will most likely be taxable.

As of this writing, Maryland does not comply with ARPA. You can read about a tax credit available to those who have student debt in our Quick Guide: Maryland Student Loan Debt Relief Tax Credit.

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Published on June 13, 2022