Student Loan Forgiveness: What It Can Mean For You

Photo by Josh Mills on Unsplash

President Biden has now cancelled more than $40 Billion in student loan debt. While some of this debt has not affected your household, it has been a tremendous relief for others. I understand that many of you are still waiting for him to forgive $10,000; there are certain things you should be thinking about in case he does.

President Biden made all student debt forgiveness and discharge tax-free on the federal level, regardless of loan type or program, when the American Recovery Act was passed in March 2021.

In reality, certain student loan forgiveness programs (Direct, FFEL or Perkins) were taxable on the federal level prior to the American Rescue Plan Act of 2021.

One of the issues with student loan forgiveness begins with how student loan forgiveness is defined. There are four basic occurrences that are categorized as “student loan forgiveness” by most people:

1. Public Service Debt Forgiveness (PSLF) and Teacher Loan Forgiveness (TLF) are two federal student loan forgiveness programs.
2. There are student debt repayment assistance programs available, including those sponsored by states and private groups.
3. There are programs for closed institutions, fraudulent certification, underpaid refunds, and death and disability that can cancel or discharge student loans.
4. Pay As You Earn (PAYE) and Income-Based Repayment (IBR) are two student loan repayment programs that offer forgiveness as part of their repayment schedule.

According to my research into state tax rules, you may still have to pay a “tax bomb” to your state on student debt forgiveness. In certain places, debt forgiveness is treated as taxable income. If you have $10,000 in forgiven student loans, for example, that money is added to your income and taxed.

Currently, 11 states do not have a state income tax, making debt forgiveness tax-free, and 20 states follow federal tax laws, making loan forgiveness tax-free. There are 19 states where student loan forgiveness is either tax-free or it’s not:

Alabama

Arizona

Arkansas

California

Georgia

Hawaii

Idaho

Indiana

Kentucky

Maine

Minnesota

Mississippi

New Jersey

North Carolina

Pennsylvania

South Carolina

Virginia

West Virginia

Wisconsin

My advice, if you think that student loan forgiveness is in your future, prepare for the tax bomb that is coming your way if you live in a state that charges taxes. Put money aside or be prepared to create a payment plan with the IRS. As always, consult a professional if you have any questions about your taxes.