California to Tax President Biden’s Student Loan Forgiveness

President Biden’s announcement of up to $20,000 in broad federal student debt forgiveness likely came as a relief for millions of eligible borrowers. Still, it also brought with it plenty of questions.

Fortunately, the White House later issued a press relief that answered many of these queries, including confirming that this debt relief won’t be subject to the federal income tax. However, whether or not it will be considered income for state income tax purposes is still less specific.

While some states, such as New York, have already assured residents their student debt forgiveness won’t be taxed, California became the first state to confirm the opposite this week.

Here’s what to know.

Student Debt Relief & Income Taxes

Generally speaking, any taxable amount of forgiven or discharged debt is treated as ordinary income and is therefore subject to federal and (potentially) state income taxes, per Internal Revenue Service (IRS) requirements.

While the American Rescue Plan Act exempts certain discharged federal, private, or educational student loans from federal income taxes until Sept 30, 2025, state governments can still make their own decisions on how to treat forgiven debt.

Most states either don’t levy a state income tax or have already passed laws that at least somewhat follow the federal treatment of student loan relief. However, a small number of state governments are currently on track to levy their respective income tax on the canceled educational debt.

What makes California’s decision somewhat surprising is that even though its existing statutes indicate taxability for student loan forgiveness, state consensus previously ran in the opposite direction.

Nevertheless, the Tax Foundation has confirmed that discharged student loan debt will be taxed under current California law. Additionally, existing state provisions exempting student loans canceled as part of income-based repayment programs won’t apply.

Which States May Follow California’s Lead?

According to the Tax Foundation’s analysis, the following six states are currently on track to tax student loan forgiveness: Arkansas, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin. The Tax Foundation’s list previously included Massachusetts, but the Hoosier State has since replaced it.

Unlike California, it isn’t guaranteed that these six states will treat student loan relief as taxable income. Should state officials take action to change the existing legislature, then the final count could be even smaller by the time borrowers receive their student debt forgiveness.

The Tax Foundation expects other states to issue guidance on how canceled student debt will be treated in the coming months. Given that California’s decision was somewhat unexpected, residents of any state without confirmed tax treatment for Biden’s student loans forgiveness would do well to periodically check with their respective state tax agencies for any new announcements.

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