Update: The student loan forgiveness application is now available through December 31, 2023.
The IRS won’t tax student loan relief, but some states might.
In August, President Joe Biden announced up to $20,000 in debt cancellation to Pell Grant recipients with loans held by the US Department of Education and up to $10,000 in debt cancellation to non-Pell Grant recipients. Borrowers are eligible for this relief if their income is less than $125,000 ($250,000 for married couples).
To ensure a smooth transition to repayment and prevent unnecessary defaults, the pause on federal student loan repayment is extended one final time through December 31, 2022. Borrowers should expect to resume payment in January 2023.
Is student loan forgiveness a taxable event?
While the discharge of debt is generally a taxable event, the American Rescue Plan Act eliminated taxes on loan forgiveness through 2025. Therefore, this debt relief will not be taxable income for federal tax purposes.
But, while the student loan forgiveness plan is tax-free on federal returns, it may trigger tax liability in at least 13 states, according to a new Tax Foundation analysis.
“States which follow the federal treatment here will likewise exclude debt forgiveness from their state income tax bases,” wrote Jared Walczak, vice president of state projects with the Center for State Tax Policy at the Tax Foundation. “But, for a variety of reasons, not every state does that.”
As a conformity state, Maryland generally conforms to federal income tax laws except where the General Assembly has enacted decoupling legislation. As such, Maryland will not treat student debt relief as taxable income.
However, several states have not fully conformed to the ARPA student debt relief provisions. Without legislative action, those states could consider student loan forgiveness taxable for state income tax purposes.
According to the Tax Foundation analysis:
Preliminarily, it appears that 13 states have the potential to tax discharged student loan debt, though the final count could be significantly smaller if states make legislative changes or administratively determine that the debt forgiveness can be excluded, or if conformity dates are updated retroactively.
Read more about the federal student relief plan here.
Read the Tax Foundation analysis here.