Though President Joe Biden just announced student debt forgiveness, some states may have to consider student loan debt forgiveness a taxable event, which would then detract from the promised $10,000 in debt cancelation.
But taxes at the state level are different and could offer a setback for borrowers in at least 13 different states, the Tax Foundation reported.
“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,” the Tax Foundation reported.
Under the current laws for many states, the tax code typically treats forgiven or canceled debt as taxable income, according to the Tax Foundation.
“If a borrower has debt forgiven, it is treated as if the borrower earned additional income in the previous tax year equal to the amount of forgiven debt. For example, if a borrower with an annual taxable income of $35,000 owes $20,000 in debt that is subsequently forgiven or canceled, the $20,000 in debt is added to their taxable income for a total of $55,000,” the Tax Foundation explained.
The Tax Foundation listed 13 potential states where the $10,000 in student loan debt forgiveness could be taxed, according to the state laws.
Pennsylvania would have the lowest possible tax of $307.
In Arkansas, Kentucky, Massachusetts, Mississippi, Virginia and Wisconsin, debt forgiveness could be taxed between $500 to $575, depending on the specific state.
In Idaho, the tax would be $600, while in West Virginia it would be $650, and in New York, it would be about $685.
South Carolina would have a tax of $700, while Minnesota and Hawaii would have the highest taxes on debt forgiveness at $985 and $1,100 respectively.
But though the state tax laws are a definite hurdle for the loan forgiveness plan, the Tax Foundation also reported that some states may eventually take action to avoid having these taxes on the canceled debt.
“In the coming weeks and months, we are likely to see states issue guidance on the treatment of discharged student loan debt,” the Tax Foundation noted.
In fact, a problem very similar to this happened during the pandemic with the Paycheck Protection Program, Forbes reported.
The PPP loan forgiveness was not federally taxed, but some states could have legally taxed it at the state level.
When several states ran into this issue, some decided to pass legislation to conform state tax law to federal law, at least temporarily, so people could benefit from the federal program.
It has yet to be seen how states will now react to the student loan debt forgiveness structure, but this added complication should be a lesson for the Biden administration that such broad and expensive ideas are nearly never as simple as they seem once reality sets in.
With a sweep of the executive order wand, Biden thought he was setting up a plan that would make millions happy by forgiving chunks of debt.
But between political pushback on the plan and the complication of tax codes that could raise taxes on borrowers with forgiven debt, the administration has muddied the waters.
The comical part of it all is that $10,000 in student loan debt forgiveness barely scratches the surface of many individuals’ debt.
“The average federal student loan debt balance is $37,667 while the total average balance (including private loan debt) may be as high as $40,274,” the Education Data Initiative reported.
While that is the average, there are also more than 3 million people with student loan debt that is greater than $100,000, “with approximately 900,000 of that total holding student loan debt greater than $200,000,” Forbes reported.
So $10,000 in debt cancellation is knocking out hardly anything for millions of people.
In the meantime, the debt cancellation will either raise individuals’ taxes in several states or will complicate state tax laws by forcing state legislatures to recalibrate the tax codes.
No matter how it shakes out, the pitfalls and downsides of Biden’s plan have quickly come to the surface, showing that it might not be such a great and easy plan as Biden may have assumed.
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