Tax Implications for Borrowers After Federal Student Loan Forgiveness

President Biden recently granted relief to over 3.7 million borrowers by forgiving more than $136 billion in student loan debt. While this brings much-needed relief, it also brings forth potential tax considerations for certain borrowers.

The debt relief covers various programs, including the public service loan forgiveness (PSLF) initiative, income-driven repayment (IDR) adjustments, disability discharges, and borrower's defense discharge. Borrowers under the PSLF program are fortunate to be tax-exempt, but others who received loan cancellation or discharge may face tax obligations.

When a debt is forgiven, the Internal Revenue Service (IRS) usually requires reporting the canceled debt as ordinary income for amounts exceeding $600. However, a temporary federal exemption, thanks to the American Rescue Plan Act (ARPA) of 2021, shields student loan forgiveness under IDR plans from federal taxation through 2025.

Despite this federal exemption, borrowers need to be aware of potential state tax obligations. Each state has its own rules, adding complexity to the situation.

Understanding State Tax Implications:

States have autonomy in setting regulations for forgiven student loans, leading to a diverse tax landscape. Some states align with federal law, treating forgiven loans as nontaxable, while others consider them taxable income.

It's crucial for borrowers to review their specific state regulations to ensure accurate income reporting. States such as Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming exempt borrowers from state taxes on forgiven student loan debt.

However, Arkansas, Indiana, Mississippi, North Carolina, and Wisconsin do not conform to the federal tax exemption on student loan forgiveness, potentially subjecting borrowers to state taxes.

Changes and Gathering Documentation:

Given the dynamic nature of tax regulations, borrowers are advised to stay informed about potential changes, especially during legislative sessions. Regular checks are necessary to stay updated on state rules.

Borrowers residing in non-conforming states might encounter challenges in receiving 1099-C forms from their student loan service providers, detailing the discharged amount. Delays and "gross servicing failures" by loan servicers may impede the timely acquisition of necessary documentation.

To address these intricate tax implications, taxpayers are strongly advised to consult with their tax professionals. A comprehensive understanding of state tax obligations and securing appropriate documentation from loan service providers is crucial for those who have experienced student loan forgiveness in the preceding year.

Also Read: What You Need to Know About Resuming Federal Student Loan Payments?