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What is the tax treatment of forgiven student loans?

Now that President Biden has announced student loan relief, the state tax treatment of forgiven loans is of interest to many ministers. Ministers who have student loans forgiven are spared a federal tax bill, but not all states treat forgiven loans the same.

A forgiven loan amount is counted as income under the Internal Revenue Code. Up until the passage of the American Rescue Plan Act (ARPA) this applied to student loans as well.

With the adoption of the ARPA, an individual can exclude from income certain student loans canceled or discharged after 2020 and before 2026.

Specifically, exclusions apply if the loan:

  • is discharged in 2018, 2019, or 2020 due to a student’s death or total permanent disability;
  • is discharged in 2021 through 2025 for any reason;
  • is canceled or discharged in any tax year if the student works for a specified period in certain professions for a broad class of employers; or
  • if the student receives repayments of forgiveness of student loans as a participant in certain public health programs or due to certain school closures.

How do states treat forgiven student loans?

Many states follow the federal tax treatment of forgiven student loans. However, some states count the forgiveness amounts as taxable income.

In which states might students incur a tax bill?

The following states do not currently follow the federal tax treatment of forgiven student loans. 

The states below do not use federal income as a starting point and will tax the forgiven loans:

  • Arkansas
    • One of a handful of states which does not conform to the Internal Revenue Code in any significant way, Arkansas’s tax code is silent on the treatment of student loan debt forgiveness, and the ordinary rule—that a discharge of indebtedness constitutes taxable income—should prevail absent state action.
  • Mississippi.
    • Another state which largely goes its own way in defining its tax base, Mississippi retains the ordinary treatment of discharged debt and is in line to tax student loan debt forgiveness.

States that have not updated conformity to the ARPA loan forgiveness provisions and, as of now, will tax the forgiven loan amounts include:

  • Minnesota;
    • Minnesota’s conformity date is December 31, 2018, which is well prior to ARPA, and the state currently lacks any other provision to exclude student loan debt cancellation from income.
  • North Carolina;
    • Although North Carolina conforms to a post-ARPA version of the Internal Revenue Code, its conformity statute contains an add-back which taxes on student loan debt forgiveness despite the federal change.
  • Wisconsin.
    • With a conformity date of December 31, 2020, Wisconsin is currently in line to tax student loan debt forgiveness.

Which states are not taxing the forgiven loans?

States that have conformed to the federal treatment, do not tax forgiven loans, or announced that they are not taxing the forgiven student loans, include:

  • Alabama;
  • Arizona;
  • California;
    • The statutes seemed to indicate taxability but where the state consensus ran in the other direction, California has now confirmed that it will, in fact, tax student loan debt discharge under current law. The state’s conformity date is January 1, 2015, and provisions of an existing law exempting student loans canceled pursuant to income-based repayment programs will not apply.
  • Colorado;
  • Connecticut;
  • Delaware;
  • District of Columbia;
  • Georgia;
  • Hawaii;
  • Idaho;
  • Illinois;
  • Indiana;
    • Although Indiana has a post-ARPA conformity date, the state statutorily decouples from IRC § 108(f)(5), which contains the exemption of forgiven student loan debt.
  • Iowa;
  • Kansas;
  • Kentucky;
  • Louisiana;
  • Maine;
  • Maryland;
  • Massachusetts;
  • Michigan;
  • Missouri;
  • Montana;
  • Nebraska;
  • New Jersey;
  • New Mexico;
  • New York;
  • North Dakota;
  • Ohio;
  • Oklahoma;
  • Oregon;
  • Pennsylvania;
  • Rhode Island;
  • South Carolina;
  • Utah;
  • Virginia;
  • Vermont; and
  • West Virginia.
     

In the coming months, we are likely to see additional states issue guidance on the treatment of discharged student loan debt, and perhaps even adopt legislative fixes, causing this list to dwindle further.

To that point, analysis should never be construed as tax advice, but that is particularly true here. While this represents a preliminary interpretation of how states are likely to treat student loan debt as of the date of this posting, this list should not be relied upon for tax purposes. Absent direct state guidance on the treatment of student loan debt relief affected taxpayers should consult with their tax advisor.

States that do not tax income, or that have a limited tax, include Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.

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Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.

This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.

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