What does the new student loan forgiveness mean for your taxes? In August 2022, President Biden announced a three-part plan that promises the cancellation of $10,000 in student loan debt for low- and middle-income borrowers. Here are the changes you’ll see this year regarding student loan taxes.
Student Loan Forgiveness Isn’t New in the Tax and Finance Worlds
There are dozens of ways students and former students can get their student loan debts forgiven, canceled, or discharged.
There are also many reasons why a student would seek these solutions to help pay or mitigate their debts:
- Death or disability
- Closed school
- Public service or teacher loan forgiveness
- Bankruptcy or eligibility for parent borrowers
- And many more
What Does the Latest Student Loan Forgiveness Look Like?
According to the White House, the three-part plan introduced in August tasks the Department of Education with the following:
- Provide targeted debt relief to address the financial harms of the pandemic
- Make student loans more manageable for current and future borrowers by cutting undergraduate payments in half and fixing the issues within the Public Service Loan Forgiveness program
- Protect future students and taxpayers by reducing the cost of college and holding schools accountable for price increases
If every single eligible borrower claims the relief they are entitled to under this new program, 43 million people will reap the benefits, with about 20 million of these students and former students having the full remainder of their balance canceled.
Student Loan Taxes Vary by State
Though the American Rescue plan makes student loans tax-free at the federal level through 2025, state income tax eligibility depends on how the states have their current tax codes written in accordance (or not) with the new federal initiatives.
Initially, the Tax Foundation estimated that 13 states would likely tax student loan forgiveness transactions. That estimate has been amended to include seven states: Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin.
The difference in the state’s treatment of the student loan taxes and forgiveness really boils down to whether the student loan forgiveness is seen as debt cancellation or income. If it’s seen as debt cancellation, like in California, there are no associated taxes. However, in a state like Indiana, where debt forgiveness isn’t seen as a reduction in debt, it’s actually considered positive income, and thus, will be subject to the state’s current income tax regulations.
Estimating Your Student Loan Taxes & Liability for State Filing
Student loan taxes are going to be more complicated this year, at the state level. If you reside in a state with a flat income tax rate, you can likely estimate your tax liability by multiplying your forgiven amount by the flat percentage. This is harder to do if you live in a state that has a graduated income tax system.
Graduated income tax systems mean that your income tax percentage increases in tiers, depending on that income amount. The more you make, the higher percentage you’ll pay in income taxes. These graduated systems often tax each tier differently. For simple math, for example, you may pay 1% income tax on every dollar you earn from $0-%10,000, 2% on every dollar from $10,001 to $29,000, and up it goes.
Because of these varied rates at different income levels, the math for your student loan taxes in these states will be a bit trickier. Here is a great resource for seeing the tax rates in different states and how they’ll affect your student loan taxes and filing.
Because we are more than halfway through the year and this student loan forgiveness may end up costing you some money on your state taxes, it’s important to anticipate and start saving for those expenses now. If new legislation or direction for the state-level handling of student loan forgiveness, you’ll enjoy some extra savings. But it isn’t wise to wait until the 2023 tax season to start thinking about how that additional $10,000 to $20,000 will affect you when you file your income taxes and your tax return as a whole.
Student Loan Taxes & W-2 Confusion? We Can Help
For those states that consider the student loan forgiveness amounts (up to $20,000 for the most qualified taxpayers) taxable income, that amount will have to be added to the amount reported on your W-2s.
Because these information returns may not reflect your eligibility for student loan forgiveness, it’s essential to keep your information returns (for your personal finances and your business finances) organized and cataloged. That’s where eFile360 can help. We store your information returns year over year and can assist with e-filing and printing and mailing state and federal information returns.
Do you have questions about information returns and how they relate to the latest tax code changes? Sign up for a free eFile360 account today.