Handful of states debate whether to tax forgiven student loans

A handful of states could still end up taxing President Biden’s recently announced student loan forgiveness of up to $20,000, according to the Tax Foundation, which could add almost $1,000 to some folks' tax bills.

Arkansas, Minnesota, North Carolina, and Wisconsin currently lack guidance or have laws indicating support for taxation — as North Carolina's Department of Revenue noted this week — but experts believe most of them will pass new legislation to change their position. Mississippi's Revenue Department also confirmed this week it would tax the forgiven debt, but new legislation could change that.

What these states ultimately decide is financially significant for their taxpayers who could face up to $985 in additional tax liability for a forgiven $10,000 loan if the states confirm non-exemption.

"There aren't many state legislators who are eager to tax it," Jared Walczak, vice president of state projects at the Tax Foundation, told Yahoo Finance. "Especially since even if an individual receives $10,000 in student loan debt forgiveness — that's significant — but it doesn't mean they have an additional $10,000 in their bank account right now to pay these taxes."

The student loan relief package announced by President Biden last week guaranteed that amounts canceled are not taxable for federal purposes under the American Rescue Plan Act (ARPA). And while most states followed this treatment and established forgiven debt as a nontaxable event, these states' verdicts remain debatable due to unambiguous state laws or lack of official clarification.

Experts believe most of them will pass new legislation to change their position for multiple reasons.

"Revenue has been increasing for a number of years, so if anything, states have been cutting taxes over the last couple of years, regardless of where policymakers stand on student loan debt forgiveness," Walczak said.

For instance, North Carolina had scheduled to drop the individual income tax rate from 5.25% to 4.99% in 2022 and 3.99% in 2026.

"We were facing a similar situation under the PPP (Paycheck Protection Program), my understanding is that those were forgiven (with exceptions in certain states)," said Carl Davis, research director at the Institute on Taxation and Economic Policy. "I think we are going to see a very similar level of consensus here."

Here is the latest.

Arkansas

Asa Hutchinson, the state’s Republican governor, tweeted last week that President Biden's student loan forgiveness plan is a misuse of executive authority that shifted the burden to taxpayers. The current Arkansas tax code treats discharged debt as taxable income even though it does not address student loan forgiveness specifically.

North Carolina

Current North Carolina tax law diverges from the American Rescue Plan's forgiveness provision. The state's Department of Revenue issued a statement on Wednesday confirming the taxable treatment until the General Assembly makes further changes before the tax-filing season. For now, canceled debt remains taxable.

Wisconsin

The Wisconsin Legislature last updated the state's tax code to conform with federal law through December 31, 2020 — before Congress passed the American Rescue Plan that exempts student loan debt. A spokesperson with Wisconsin's Department of Revenue told a local news station that “excluding debt forgiveness from being taxes, in this instance, requires a statutory change,” as the state tax code explicitly says federal student loan forgiveness was ineffective for the state.

Minnesota

Minnesota last conformed to the federal tax code through December 31, 2018, well before the American Rescue Plan. The state provision does not have language that excludes national forgiven debt from being taxable, and no further guidance has been given.

Mississippi

The state's Department of Revenue told Bloomberg News it would consider the forgiven student debt taxable. But that could change before tax season if a new law is passed. The state did forgive PPP loans in 2021.

States must act fast

State policymakers looking to exclude forgiven loans from taxable income are challenged with a limited timeline. They still need to rewrite or pass new laws during state sessions well before the tax season and the federal tax filing deadline.

"It has to be in effect in time for the tax-filing season that usually requires what's called an emergency clause. Something that makes the law into effect as of the date of enactment," Walczak said. "And that in most states requires a supermajority. Now this may not be very controversial, it may be easy to achieve that, but it is one more logistical hurdle that the states would have to clear."

As the states discuss the issue, Davis hopes this is just the beginning of a bigger conversation regarding college affordability.

"The states have a lot of control over questions of college affordability — they decide how much to budget for financial aid and what kind of laws to write that govern public school tuition cost," Davis said. Right now, "college is very much unaffordable for a lot of families."

Rebecca is a reporter for Yahoo Finance.

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