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Will your state tax your canceled student loans?

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By Cara Smith | NerdWallet

Several states are set to levy income taxes on student loan forgiveness — a move that could leave some borrowers owing up to $1,000 during tax season.

Individuals in Indiana, Mississippi and North Carolina will almost certainly pay state income taxes on their canceled federal student loans, according to tax officials in those states and analysis by the Tax Foundation, a tax policy think tank based in Washington, DC.

Meanwhile, a handful of other states are tentatively considering taxing canceled student loan debt unless their legislatures take action to prevent it.

According to the White House, President Joe Biden’s August 24 executive order could erase all remaining federal student loan debt for as many as 20 million borrowers and reduce debt for millions more. In general, borrowers are eligible for debt forgiveness of up to $20,000 if they earn less than $125,000 and file taxes as an individual or if they are married, file jointly and earn less than $250,000.

Although the federal government explicitly stated in the American Rescue Plan Act of March 2021 that it would not collect taxes on canceled student debt until December 31, 2025, not all states are bound by the same commitment. Here’s what we know about the rest.

Arkansas

Canceled student debt is expected to be taxed as income in Arkansas. However, that will change if the state legislature takes action, Scott Hardin, spokesman for the Arkansas Department of Finance and Administration, said in an email. Hardin noted that the state legislature moved to exempt PPP loans from taxation and froze taxation on unemployment benefits for two years.

Arkansas has a progressive income tax rate that ranges from 2% to 4.9% depending on annual income, according to the state’s Economic Development Commission. Individuals earning less than $5,000 are exempt from state income tax.

California

Canceled student debt will be taxed as income in California, California Franchise Tax Board spokesman Andrew LePage said in an email. This is because student loan forgiveness does not occur under section 1098-E of the federal education code, LePage said, and therefore does not meet a requirement for exclusion in the state tax code. Section 1098-E, titled “Income-Based Reimbursement,” is found in Chapter 28 of the Federal Education Code, which pertains to higher education and student financial aid, according to the US Government Publishing Office.

If the federal government declares the program to be running under Section 1098-E, borrowers would not have to pay taxes on that debt in California, LePage said.

Indiana

Indiana residents will be taxed on canceled student loan debt, Natalie Rodriguez, assistant director of communications at the Indiana Department of Revenue, said in an email.

The state income tax rate is 3.23%, so individuals could pay up to $323 in taxes for $10,000 in student loan forgiveness or $646 for up to $20,000 in student loan forgiveness, Rodriguez said. Indiana residents will also have to pay additional county taxes on canceled debts, Rodriguez said.

Minnesota

In Minnesota, canceled student debt should be taxed as income, Minnesota Department of Revenue spokesman Ryan Brown said in an email. However, that will only change if the state legislature takes specific action, Brown said.

Minnesota has a progressive income tax rate, based on your annual income. The tax rate ranges from 5.35% for people earning no more than $28,080 to 9.85% for people earning more than $171,220, according to the state Department of Revenue.

Mississippi

Mississippi should tax canceled student loan debt as income, according to the Tax Foundation. The Mississippi Department of Revenue could not be reached for comment by NerdWallet.

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

North Carolina

Canceled student loan debt should be taxed as income in North Carolina, Thomas Beam, public affairs officer at the North Carolina Department of Revenue, said in an email. But the rate at which individuals will be taxed remains uncertain.

The state personal income tax is currently 4.99%, but this figure increases to 4.75% in 2023 and gradually decreases until 2026 when the rate will be 3, 99%, according to the State Department of Revenue.

Wisconsin

As it stands, canceled student loan debt will be taxed as income in Wisconsin. Changing that would require specific action by the state legislature, Patty Mayers, director of communications at the Wisconsin Department of Revenue, said in an email. That action hasn’t happened yet, Mayers said, but it could still happen in January when the state legislature is back in session.

“We addressed this discrepancy with federal law in our department’s biennial budget request, in an effort to ensure that Wisconsin taxpayers do not incur penalties and increased taxes for canceling their loans.” , Mayers said.

The Wisconsin income tax rate ranges from 3.54% to 7.65%, depending on annual income and whether you are married or single, according to the state Department of Revenue.

How to prepare if you are affected

Whether these taxes are due during the 2022 tax season (early 2023) or the 2023 tax season will depend on a few factors, including when an individual completes the U.S. Department of Education’s Debt Cancellation Application. The form is expected to be available in October and end in December 2023, according to the Ministry of Education website.

If you live in a state that could tax your canceled 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 need to set aside on each paycheck.

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Cara Smith writes for NerdWallet. E-mail: [email protected].