Forgiveness: Tax Impact of Student Debt Cancellation.

• Author: Bogart, Jennifer

On Aug. 24, the White House announced a new three-part plan to provide student debt relief for qualifying borrowers. Qualifying borrowers include individual taxpayers with income under $125,000 and households with income under $250,000 with outstanding federal student loans.

Qualifying borrowers who received at least one Pell Grant may receive up to $20,000 in student debt cancellation; those who did not may receive up to $10,000 in student debt cancellation. The cancellation is limited to the outstanding balance remaining on the qualifying borrower's federal loan at the time forgiveness is sought, if that amount is less than the $20,000/$ 10,000 maximum.

As a general rule, cancellation of indebtedness is taxable income for federal tax purposes. In 2021, however, Congress passed, and the President signed, the American Rescue Plan Act (ARAP). Sec. 9675 of this legislation provides that student loan forgiveness occurring between 2021 and 2025 is not taxable for federal purposes. Therefore, loans cancelled under the President's recent plan would not be subject to federal tax.

Conformity Issues

It's important to understand if your state is conforming to the most recent IRC. Those that do would include the new ARPA provisions from 2021, making cancellation of student loan debt non-taxable for state purposes as well as federal purposes. States that do not conform to the current IRC, may have separately passed ARPA provisions or similar legislation, also making student loan cancellation non-taxable for state income tax purposes.

In contrast, a handful of states, including California, do not conform to the current IRC and have not otherwise passed legislation to make student loan debt cancellation non-taxable. In these states, the loans forgiven under President's recent plan would be subject to state income tax.

Considering that the upper income limits for both single individuals and households fall squarely in California's 9.3 percent tax bracket, this means that a taxpayer who receives the maximum $20,000 loan forgiveness may owe an additional $ 1,860 in California state tax as a result of the loan forgiveness plan.

In California, relief may come before the 2022 tax filing deadline arrives. At least two members of the California Legislature have taken to Twitter to declare that the state government will take legislative action before the 2022 tax filing deadline, to provide a tax exemption for cancellation of student loan debt.

The default tax...