Tax on Student Loan Forgiveness?

Will you owe tax on the new student loan forgiveness? It depends where you live.

One way taxes are weird is when you have taxable income without actually having received money. You can end up in a spot where you owe tax, but don’t have the cash to pay your tax bill.

Cancelled debts are an example. You borrow money, you don’t repay the loan in full, and the outstanding balance may be taxable income to you. The rationale is that a loan balance you don’t repay is the same as receiving that amount in cash; often receiving cash is taxable.

Forgiven student loans have historically been treated as taxable income. While having the debt removed puts you in a better financial position, owing taxes on the forgiven balance can be a big cash flow hit itself. In some circumstances, forgiven student loans are NOT taxable. Healthcare workers in underserved areas have been able to exclude student loans from taxable income for some time. More recently, student loans forgiven from 2021 to 2025 are generally not considered taxable income under the American Rescue Plan Act of 2021.

The White House recently announced student loan forgiveness of up to $20,000 for taxpayers with income under $125,000 (single)/$250,000 (married filing joint). It’s not yet clear if “income” means adjusted gross income, taxable income, or some other calculation. We do know, though, the income number will come from either your 2020 or your 2021 tax returns. https://studentaid.gov/debt-relief-announcement/one-time-cancellation.

With all this in mind, the FEDERAL government will not be taxing forgiveness under the new program. States, though, may. For states that tax individuals, federal income is typically the starting point for their calculations. From there, though, each state may add or subtract items as it chooses. Certain states continue to include student loan forgiveness in taxable income after the American Rescue Plan Act and will likely tax the new forgiveness, as well. States expected to tax the newly-forgiven amounts include California, Mississippi, and North Carolina. My home state of Georgia likely will conform to the federal rules and NOT tax forgiveness. https://taxfoundation.org/student-loan-debt-cancelation-tax-treatment/

I expect more details from the both the federal and state governments over the coming months. Stay tuned!