Student loan forgiveness is a program that helps borrowers pay off their student loans early. There are several different types of student loan forgiveness programs, and the eligibility requirements vary. However, one common question that borrowers have is whether student loan forgiveness is taxable.

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Is student loan forgiveness taxable?

Federal law exempts student loan forgiveness from federal taxes. This means that borrowers who receive federal student loan forgiveness will not have to pay taxes on the amount forgiven. However, some states have their own tax laws that may tax student loan forgiveness.

Which states tax student loan forgiveness?

Only four states currently tax student loan forgiveness:

Arkansas
Indiana
Mississippi
North Carolina

Federal law

Congress exempted student loan forgiveness from federal taxes in the American Rescue Plan Act of 2021. There are a few reasons why Congress did this. First, student loan forgiveness can help borrowers get out of debt and achieve financial stability. Second, taxing student loan forgiveness would discourage borrowers from participating in these programs. Third, taxing student loan forgiveness would be unfair to borrowers who have already made significant payments on their loans.

State laws

The states that tax student loan forgiveness have different reasons for doing so. Some states argue that student loan forgiveness is a form of income, and therefore should be taxed. Others argue that taxing student loan forgiveness helps to ensure that all taxpayers contribute to the state’s budget.

Arguments for and against taxing student loan forgiveness

There are strong arguments for and against taxing student loan forgiveness.

Arguments in favor of taxing student loan forgiveness:

Student loan forgiveness is a form of income, and therefore should be taxed.
Taxing student loan forgiveness helps to ensure that all taxpayers contribute to the state’s budget.
Taxing student loan forgiveness can help to reduce the overall cost of student loan forgiveness programs.

Arguments against taxing student loan forgiveness:

Taxing student loan forgiveness would discourage borrowers from participating in these programs.
Taxing student loan forgiveness would be unfair to borrowers who have already made significant payments on their loans.
Taxing student loan forgiveness would reduce the financial benefits of student loan forgiveness for borrowers.

States that tax student loan forgiveness

The four states that tax student loan forgiveness have different tax laws for student loan forgiveness.

Arkansas: Arkansas taxes student loan forgiveness as ordinary income.
Indiana: Indiana taxes student loan forgiveness as ordinary income, but borrowers can deduct up to $10,000 of student loan forgiveness from their state income taxes.
Mississippi: Mississippi taxes student loan forgiveness as ordinary income, but borrowers can deduct up to $2,500 of student loan forgiveness from their state income taxes.
North Carolina: North Carolina taxes student loan forgiveness as ordinary income, but borrowers can exempt up to $15,000 of student loan forgiveness from their state income taxes.

How much tax do you owe on student loan forgiveness?

The amount of tax you owe on student loan forgiveness will depend on your state’s tax laws and your income. To calculate the amount of tax you owe, you will need to know the following information:

The amount of student loan forgiveness you received.
Your state’s marginal tax rate.

Once you have this information, you can use the following formula to calculate the amount of tax you owe:

Tax owed = (Amount of student loan forgiveness) * (State marginal tax rate)

Strategies to reduce your tax liability

There are a few strategies you can use to reduce your tax liability on student loan forgiveness.

Make extra student loan payments before forgiveness. If you make extra student loan payments before your loans are forgiven, you will reduce the amount of forgiveness you receive. This will lower your tax liability.
Consider income-based repayment plans. Income-based repayment plans cap your monthly student loan payments at a percentage of your income. If you are on an income-based repayment plan, you may be able to reduce the amount of your student loan forgiveness.
Refinance your student loans. If you refinance your student loans to a lower interest rate, you may be able to reduce the amount of your student loan payments. This could lead to more student loan forgiveness, which could reduce the amount of tax you owe.

Tax implications for different types of student loan forgiveness (continued)

Income-driven repayment forgiveness: Income-driven repayment forgiveness is a program that forgives the remaining balance on your federal student loans after you have made 20 or 25 years of qualifying payments. Income-driven repayment forgiveness is not taxable at the federal level, but it may be taxable at the state level depending on your state’s tax laws.
Borrower defense to repayment: Borrower defense to repayment is a program that forgives the remaining balance on your federal student loans if you were defrauded by your college or university. Borrower defense to repayment is not taxable at the federal level, but it may be taxable at the state level depending on your state’s tax laws.
Other types of student loan forgiveness: There are a number of other types of student loan forgiveness programs, such as forgiveness for teachers, nurses, and veterans. The tax implications for these programs vary depending on the specific program.

Conclusion

If you are considering student loan forgiveness, it is important to be aware of the potential tax implications. If you live in a state that taxes student loan forgiveness, you may owe taxes on the amount forgiven. There are a few strategies you can use to reduce your tax liability, such as making extra student loan payments before forgiveness, considering income-based repayment plans, and refinancing your student loans.

What to do if you live in a state that taxes student loan forgiveness

If you live in a state that taxes student loan forgiveness, there are a few things you can do to prepare:

Talk to a tax advisor. A tax advisor can help you understand your state’s tax laws and calculate the amount of tax you owe on student loan forgiveness.
Make a budget. Once you know how much tax you owe, you can make a budget to pay it off.
Consider other options. If you are unable to pay the tax on your student loan forgiveness, you may want to consider other options, such as negotiating with the state tax authority or applying for a tax relief program.

Resources for more information on student loan forgiveness taxes

IRS website,: The IRS website has a number of resources on student loan forgiveness taxes, including Publication 524, Tax Information for Education Savings and Education Expenses.
Federal Student Aid website,: The Federal Student Aid website has a number of resources on student loan forgiveness, including a section on the tax implications of student loan forgiveness.
State tax authority website: You can find information on your state’s tax laws on the website of your state tax authority.

Conclusion

Student loan forgiveness can be a life-changing event, but it is important to be aware of the potential tax implications before you accept it. If you live in a state that taxes student loan forgiveness, you may owe taxes on the amount forgiven. However, there are a number of strategies you can use to reduce your tax liability.

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