(PresidentialInsider.com)- Many federal student loan borrowers rejoiced recently when President Joe Biden signed an executive order that could cancel at least $10,000 in debt for some of them.
However, this loan forgiveness could turn into an extra tax bill for borrowers who live in some states.
Forbes reported that the Biden administration said this forgiveness would be exempt from all federal taxes. That doesn’t account for state taxes, though, which are handled completely separately.
A report from the Tax Foundation showed that borrowers in at least 13 states could face additional taxes as a result of the loan forgiveness, as it could be termed as ordinary income.
As the foundation reported recently:
“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.”
Many states currently treat any debt that is canceled or forgiven as taxable income, the foundation said. However, they further explained:
“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.”
That could be a significant amount of extra state taxes that could be owed. Thus far, the foundation has said that there are 13 states that could end up treating this debt forgiveness as taxable income.
Pennsylvania is the one where the tax impact would be the lowest, with potentially $307 of additional state income tax being owed on that $10,000 of debt forgiveness.
In Wisconsin, Virginia, Mississippi, Massachusetts, Kentucky and Arkansas, the forgiveness could result in additional state taxes between $500 and $575.
There could be an addition $600 in state taxes in Idaho, an additional $650 in West Virginia, and an addition $685 in New York.
South Carolina borrowers might see an additional $700 in state taxes, while those in Hawaii and Minnesota could face the highest potential additional state tax bills of $1,100 and $985, respectively.
Having to pay this additional state taxes would certainly be preferable to most borrowers over the $10,000 in student debt that is being canceled. However, it does create sort of an interesting potential financial conundrum. While the student loan debt was likely being financed over time — through monthly payments — the additional state taxes would all be due next April, unless an extension is filed or payment plan agreed upon.
While not all borrowers would actually owe anything out of pocket, it could reduce or wipe away an expected state tax return.
It’s still possible, as the Tax Foundation said, that states will now update their tax laws to adjust for the loan forgiveness and waive all state taxes on it.
