This article was written by Shailana Dunn-Wall, Tax Law Project Attorney
This article was last updated October 27, 2022.
On August 24, President Biden announced the Department of Education will cancel up to $20,000 in federal student loan debt for borrowers whose annual income is below $125,000 or $250,000 for borrowers who file taxes as “married filing jointly”. Learn more about the specifics of the debt relief here.
This is great news for many struggling families, but it raises many questions too. If you’ve ever had debt relief before, you may be wondering if you’ll have unexpected tax bill next spring. Many types of loan forgiveness can be considered “income” by the IRS.
For example, Devi and Ben are a married couple. They both work, but can only afford very low-coverage health insurance. Devi unfortunately has an accident and is temporarily paralyzed. The medical bills total $25,000, even after insurance, which is more than Devi and Ben can afford to pay. They discuss their situation with the hospital and settle with the hospital: Devi and Ben will make payments over a period of time, totaling $5,000 and the hospital will write off (or forgive) the remaining $20,000.
Because Devi and Ben received $20,000 of debt relief, the hospital will likely send them a 1099-C form the next January, showing $20,000 of income. Even though Devi and Ben didn’t receive a payment of $20,000 from the hospital, the IRS considers the amount of forgiven debt as income and Devi and Ben will need to pay tax on the $20,000 – which will be significantly less than the $20,000 they originally owed. Devi and Ben are in a better position than they would have been without the debt forgiveness, however, they will still need to pay more on their taxes than they normally do.
As part of the American Rescue Plan Act (ARPA), the Department of Education made this forgiveness of student loan debt not taxable income at the federal level.
Most of the time debt relief is considered income, but there are exceptions. As part of the American Rescue Plan Act (ARPA), the Department of Education made this forgiveness of student loan debt not taxable income at the federal level. This means people who receive the debt relief will not have to pay federal taxes on the amount forgiven (regardless of the amount of forgiveness they are eligible for). Most states have their own income tax, and while most of the states largely follow the federal standards in determining what taxable income is, there are a few that do not. If you are were a resident of or employed in Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia and/or Wisconsin, for all or part of 2022, you may need to pay state income tax on the debt forgiveness. These states will choose whether to grant the debt forgiveness tax-free status in the next few months. (If the tax free status is not granted, remember that even at the highest state tax rates, the amount of tax owed will be significantly less than $10,000 or $20,000.)
If you are a Nebraska resident who qualifies for the student loan forgiveness, you will not have to pay state or federal income tax on the debt discharge.
If you are a Nebraska resident who qualifies for the student loan forgiveness, you will not have to pay state or federal income tax on the debt discharge. Most borrowers will receive the relief automatically, but if the Department of Education doesn’t have your financial information, you may need to apply for the forgiveness.
The portal to apply for student loan forgiveness can be accessed here. Although the process is currently paused due to ongoing litigation, the application is still available. If you think you may qualify for the loan forgiveness but do not know if the government has your current financial information, learn more about that process here.
NOTE: If you are worried about your state tax bill, you can choose to opt out of the loan forgiveness.
Need additional help?
If your tax refund is taken or garnished, or if the IRS says you owe money that you did not think you owe, please call Legal Aid of Nebraska at Statewide Accessline at 1-877-250-2016
If you have questions, please visit: https://www.legalaidofnebraska.org/how-we-help/resources/tax/ or join us on the last Tuesday of each month when we partner with the IRS’ Taxpayer Advocate Service for Virtual Taxpayer Problem Solving Days.