Caution: Student Loan Forgiveness Can Increase Your Taxes

On August 24, 2022, President Biden announced plans to cancel up to $10,000 of student loan debt for individuals earning $125,000 ($250,000 for joint filers) or less for individuals who did not receive a Pell Grant. For Pell Grant recipients, up to $20,000 in student loan debt could be canceled for those who meet or who are below the earning threshold. While the announcement appears to benefit some, left unsaid are the tax implications of the loan forgiveness. For those receiving a loan write-off, an increase in income taxes is a real possibility.

In general, the discharge of indebtedness is deemed taxable income both at the federal and state levels. However, under the provisions of the American Rescue Plan Act of 2021, the forgiveness of student loan debt in years 2021 through 2025 is exempt from inclusion in federal taxable income. That said, many states do not follow the federal exemption. Instead, such discharge of indebtedness is subject to the respective state’s income tax. As a result, those residents of more than a dozen states – including Massachusetts and Pennsylvania – who receive student loan forgiveness will find themselves with a higher state income tax liability than previously expected.

Whether states will work quickly to issue modifications to exempt the taxability of the indebtedness discharge by year end is unclear, as many politicians are currently working the campaign trail in advance of the fall election season.

For more information on how the forgiveness of loan debt can unexpectedly increase your taxes, please contact your Anchin Relationship Partner.