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State and Local Tax

State Taxation of Forgiven Student Loans

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

by Thomson Reuters State & Local Tax Editorial

On August 24, 2022, President Biden announced that the U.S. Department of Education will provide up to $20,000 in debt cancellation to Pell Grant recipients with loans held by the Department of Education and up to $10,000 in debt cancellation to non-Pell Grant recipients if the borrower’s individual income is less than $125,000 ($250,000 for households). Although canceled debt is usually includable in an individual’s federal gross income, §9675 of the American Rescue Plan Act excludes such canceled debt income for discharges occurring after December 31, 2020, and before January 1, 2026. Whether a borrower is taxed at the state level on the discharged or partially discharged loan will largely depend on if and how the borrower’s state income tax code conforms to the Internal Revenue Code (Code).

Most states incorporate federal tax provisions by using federal gross, net, or taxable income as the starting point for calculating state taxable income and then applying state-specific modifications. “Rolling conformity” states generally incorporate the Code as amended and in effect for the applicable tax year. In these states, the state legislature will not need to take any action to exclude forgiven student loan income for state income tax purposes. “Static conformity” states adopt the Code as of a specified date and the legislature must pass a law to advance that date (many update the date each year while some advance the date less frequently). States may also conform to specific provisions only, carve out provisions for nonconformity, or use a different conformity date for certain Code sections. State specific tax treatment for states that have issued guidance concerning the Biden student loan forgiveness plan is discussed below.

Arkansas. The Arkansas Department of Finance and Administration (DFA) has issued a statement regarding student loan forgiveness for personal income tax purposes. The DFA stipulated that the forgiveness of a debt generally is included in a taxpayer’s gross income. However, the Arkansas General Assembly and Governor Asa Hutchison previously took action to exempt unemployment payments from state income tax for a 2-year period. Additionally, Paycheck Protection Program (PPP) loans are not subject to state income tax pursuant to legislation. The DFA said the General Assembly meets in January 2023 and may take similar action to exempt student debt forgiveness. The DFA added that it would be inaccurate to report that student loan forgiveness will be taxable in Arkansas because it will not be certain until the legislative session is complete and the complete details of the loan forgiveness plan are finalized and announced by the U.S. Department of Education. (News Release, Arkansas Department of Finance and Administration, 09/09/2022.)

Hawaii. The Hawaii Department of Taxation announced that forgiven student loan debt provided by the Biden Administration’s Student Loan Debt Relief Plan will not be taxed as income for Hawaii income tax purposes. IRC § 108 (Income from discharge of indebtedness), with the exception of IRC § 108(i), is operative for Hawaii income tax purposes under Haw. Rev. Stat. § 235-2.4(f)IRC § 108 was partially amended in 2021 by the American Rescue Plan Act (ARPA), which allowed the exclusion of qualified student loans cancelled or discharged in 2021 through 2025 from gross income. (Hawaii Dept. of Taxation Announcements No. 2022-06, 08/29/2022.)

Indiana. The Indiana Department of Revenue has announced that Indiana recipients of the Biden Administration’s student debt relief will need to include the amount of general student loan relief in their Indiana adjusted gross income (AGI), and thus must pay Indiana state and local taxes on the amount of the forgiven loan. Although Indiana’s income tax code conforms to the Code as of the relevant date, the Indiana General Assembly passed a law decoupling Indiana from IRC § 108(f)(5), thus requiring Indiana taxpayers to add back the excluded amount to their Indiana AGI. Instructions on how to do this using Add-back Code 150 will be included in tax instruction booklets and software for the 2022 tax year. (Indiana Department of Revenue Tax Bulletin, September 2022, Issue 41, 09/01/2022.)

Louisiana. The Louisiana Department of Revenue has issued a bulletin explaining the effect any federal student loan forgiveness may have on taxpayers subject to Louisiana individual income tax. For individual taxpayers in Louisiana, the starting point for determining Louisiana’s taxable income is the taxpayer’s adjusted gross income (AGI), which is the AGI of the individual for the taxable year that is reportable on the individual’s federal income tax return. Because Louisiana largely conforms to federal tax law for purposes of individual income tax, amounts that are exempt from federal tax, and, therefore, not includable in the taxpayer’s AGI, will automatically be exempt from Louisiana tax without further action. As such, for taxpayers qualifying for federal student loan forgiveness, any forgiven amounts likely will be automatically excluded from a taxpayer’s AGI and exempt from Louisiana tax. (Louisiana Revenue Information Bulletin No. 22-017, 09/14/2022.)

Massachusetts. Recently enacted Mass. Gen. L. Ch. 62 § 2(a)(2)(R), made effective January 1, 2022, allows a deduction from Massachusetts gross income in whole or in part, for income attributable to the discharge of a postsecondary education loan, a private education loan, a loan made by any educational organization or any private education lender, or a refinance of such an education loan. Also, Massachusetts’ conformity law includes the American Rescue Plan Act (ARPA), so that income from the discharge of student loans excluded by ARPA may also be excluded from Massachusetts gross income. (Massachusetts Technical Information Release No. 22-2, 01/12/2022.)

Michigan. The Michigan Department of Treasury has issued guidance on the state income tax consequences of President Biden’s student loan relief plan.  Based on Michigan’s statutory conformity to the Code, forgiven student loan will not be subject to income tax in Michigan. (Student Loan Forgiveness Not Subject to Income Tax in Michigan, Mich. Dept. Treas., 09/28/2022.)

Minnesota. The Minnesota Department of Revenue has clarified that student loan debt relief received under the Biden Administration’s Student Debt Relief Plan is included as taxable income on a Minnesota individual income tax return and does not qualify for a subtraction under current Minnesota law. Under current law, any amount of discharged student debt is generally included as taxable income on a Minnesota individual income tax return. The federal Student Debt Relief Plan is not included in the state’s current subtraction modification for certain qualified education loans that have been discharged. The Department encourages taxpayers to review their Form W-4MN (Minnesota Employee Withholding Allowance/Exemption Certificate) on file their employer, and consider changing it to have more tax withheld from the taxpayer’s paycheck. Taxpayers may also want to consider making estimated tax payments. (Cancellation of Education Loans, Minn. Dept. Rev., 09/12/2022.)

North Carolina. The North Carolina Department of Revenue has announced that President Biden’s recent student loan forgiveness will be taxed for North Carolina income tax purposes. Since the North Carolina General Assembly did not adopt IRC § 108(f)(5), student loan forgiveness is currently considered taxable income in North Carolina. (Student Loan Forgiveness Currently Considered Taxable Income, N.C. Dept. of Rev., 08/31/2022.)

Pennsylvania. Pennsylvania Governor Tom Wolf has announced that student loan borrowers who will receive up to $20,000 in relief under President Biden’s Student Debt Relief Plan will not be taxed on that relief in Pennsylvania. (Governor Wolf Reminds Pennsylvanians: Student Loan Forgiveness Will Not Be Taxed in Pennsylvania, Pennsylvania Governor’s Office, 08/31/2022.)

Rhode Island. The Rhode Island Division of Taxation has announced that Rhode Island is adhering to the federal tax treatment of student loan debt forgiveness and will not be including the discharge of up to $20,000, for qualifying individuals, in Rhode Island taxable income from January 1, 2021 through December 31, 2025. (R.I. Treatment of Student Loan Debt Forgiveness, R.I. Div. of Taxation, 09/09/2022.)

South Carolina. The South Carolina Department of Revenue has announced that to the extent a student loan described in IRC § 108 is forgiven for federal income tax purposes and excluded from federal taxable income, then the amount is also excluded from South Carolina taxable income. During the 2022 legislative session, South Carolina conformed to the Code as of December 31, 2021, including conformity to the amendment to IRC § 108(f)(5), as amended by Section 9675 of the federal American Rescue Plan Act of 2021, which temporarily added special rules for the discharge of student loans in 2021 through 2025. Since South Carolina adopts IRC § 108 to the extent a student loan described in IRC § 108 is forgiven for federal income tax purposes and excluded from federal taxable income, then the amount is also excluded from South Carolina taxable income. (South Carolina Information Letter No. 22-14, 09/01/2022.)

 

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