Will Your State Tax Your Student Loan Forgiveness?

Some states plan to collect taxes on student loan forgiveness. Here's how to prepare if you're affected.

Ongoing changes have been afoot for student loan borrowers. In October 2023, student loan repayments resumed after more than a three-year pause due to the COVID-19 pandemic.

Then in June 2023, the Supreme Court struck down the Biden-Harris Administration’s plan to offer student loan relief, which was slated to relieve borrowers up to $20,000 for Pell Grants and up to $10,000 for non-Pell Grants.

Where does this leave student loan borrowers? Here’s a look at the current loan forgiveness plans and what they mean for you in terms of taxes.

Student loan forgiveness plans

While the Biden-Harris Administration continues working toward more comprehensive student debt relief, there are several loan forgiveness programs currently available.

Income-driven repayment plans

The federal debt relief for income-driven repayment (IDR) plans is projected to forgive loans for nearly 30,000 borrowers totaling $1.7 billion.

IDR plans work by calculating student loan repayments based on income. The U.S. Department of Education offers four types of IDR plans: Saving on a Valuable Education (SAVE) Plan, formerly known as the REPAYE Plan; Pay As You Earn (PAYE) Repayment Plan; Income-Based Repayment (IBR) Plan; and Income-Contingent Repayment (ICR) Plan.

Of the four, SAVE offers significant financial benefits by decreasing monthly payments and providing potential early loan forgiveness of 10 years instead of the typical 20 to 25 years.

Individuals who borrowed $12,000 or less are eligible for the shortest forgiveness period of 10 years, with each additional $1,000 borrowed equal to one year. For example, if you borrowed $13,000 your repayment term would be 11 years; this represents an expedited payoff plan from an original 20 to 25 year projection.

Public service loan forgiveness

Recent regulatory improvements to the public service loan forgiveness (PSLF) program may stand to benefit some 43,000 borrowers to the tune of $3.2 billion in student loan debt relief, according to a January 2024 announcement from the Biden-Harris Administration.

To be eligible for PSLF, borrowers must work for the government or nonprofit organizations and make at least 120 qualifying monthly payments.

Borrower defense forgiveness

Borrowers who were misinformed by educational institutions may be eligible for borrower defense forgiveness. Under this IDR plan, six tenets qualify you for loan forgiveness: substantial misrepresentation, substantial omission of fact, breach of contract, aggressive and deceptive recruitment, judgment and prior secretarial action.

In other words, if you think your school may have misled you or made false claims about items like future job perspectives or salaries, you may be eligible for borrower defense loan forgiveness.

States that will tax student loan forgiveness

While the federal government explicitly stated in the March 2021 American Rescue Plan Act that it won't collect taxes on student debt forgiven through Dec. 31, 2025, not all states are held to the same pledge. Here's what we know about the rest.

Several states are poised to collect income taxes on student loan forgiveness. Borrowers in Indiana, Mississippi, North Carolina and Wisconsin will almost certainly pay state income taxes on some forgiven federal student loans, according to analysis from the Tax Foundation, a tax policy think tank based in Washington, D.C.

Meanwhile, a handful of other states are tentatively planning to tax forgiven student loan debt unless their legislatures take measures to prevent it.

For example, the most recent update from the Arkansas Department of Finance and Administration was in a September 2022 statement asserting forgiven student debts are expected to be taxed as income in Arkansas.

However, that'll change if the state's legislature takes action. The state's legislature took action to exempt PPP loans from taxation and froze taxation on unemployment payments for two years. It is unclear whether the Arkansas Legislature anticipates any such measures passing for student debt forgiveness.

Indiana

Indiana residents will be taxed on some forgiven student loan debts, according to the Indiana Department of Revenue’s website.

The state's income tax rate is 3.15%, so individuals could pay up to $315 in taxes for $10,000 in student loan forgiveness or $630 for up to $20,000 in student loan forgiveness. Indiana residents will also have to pay additional county taxes on the forgiven debts.

Mississippi

Mississippi is expected to tax forgiven student loan debt as income, according to the Tax Foundation. Mississippi's Department of Revenue has not provided a recent update on whether its taxation will change.

Mississippi charges a 5% income tax on all annual income over $10,000, according to the Tax Foundation.

North Carolina

Forgiven student loan debts are expected to be taxed as income in North Carolina, per North Carolina's Department of Revenue. The exception being PSLF borrowers who may be exempt from paying federal or state taxes, according to North Carolina Center for Nonprofits.

For those borrowers who will be taxed, the rate at which they will be taxed remains unclear. The state's individual income tax is currently 4.75%, but that figure changes to 4.50% in 2024 and gradually decreases until 2026, when the rate will stand at 3.99%, per the state's Department of Revenue.

Wisconsin

As it stands, forgiven student loan debts through income-driven repayment plans will be taxed as income in Wisconsin. Exclusions from state tax include loan forgiveness through PSLF, death or total and permanent disability, teacher loan forgiveness program and National Health Service Corps Loan Repayment plan.

Wisconsin's income tax rate ranges from 3.50% to 7.65%, depending on annual income and whether you're married or single, according to the state's Department of Revenue.

How to prepare if you're affected

Whether those taxes are owed during the 2023 tax season (in early 2024) or the 2024 tax season will depend on a few factors, including state and national legislation.

If you live in a state that might tax your forgiven student loans, consider using an online tax calculator to get an idea of how much you'll need to save. In many cases, your state's Department of Revenue website or its franchise tax board website will have such a calculator.

You can also consider using a budget app to automatically siphon off what you'll need to set aside from each paycheck.