Borrowers in several states could owe hundreds or even thousands at tax time.
Currently, millions of student loan borrowers are waiting to see how the US Supreme Court will rule on widespread federal loan relief. But if debt relief does go through, will you be stuck with a tax bill in 2023?
The chances are unlikely as 2022 draws to a close. But if forgiveness passes in early 2023, you may be on the hook for state or local taxes on this forgiven debt in 2024. You won't owe federal taxes on any forgiven student debt through 2025, however, thanks to a provision tucked into the $1.9 trillion American Rescue Act COVID relief package.
Whether you receive forgiveness through the federal student loan cancellation plan, Public Service Loan Forgiveness or another program, your tax liability is the same. Here's everything you need to know about how your student loans affect your tax bill. We'll also share some tax deductions to help lower your tax bill or boost your refund next year.
Although federal taxes on forgiven student debt are temporarily suspended through 2025, typically forgiven school loan balances are taxed as income. That means if you receive student loan forgiveness, this amount will be added on to your adjusted gross income (the amount you made last year minus any eligible tax deductions). So, if you make $50,000 annually and are eligible for $20,000 in debt relief, your income would be adjusted to $70,000 for the year.
States and counties also tax forgiven student debt as income.
Most states will not impose taxes on forgiven student loan balances -- but a handful will. Right now, we know Indiana, Minnesota, Mississippi and North Carolina all plan to tax forgiven student loans.
And two more states, Arkansas and Wisconsin, could follow suit, but haven't yet confirmed their tax plans.
If you live in a state that will tax forgiven student loans, how much you'll owe depends on your state and local tax rates. Some states have flat income tax rates, while others have progressive income tax rates, where you pay a higher rate if you're in a higher tax bracket.
Indiana and North Carolina both have flat tax rates (3.23% and 4.99%, respectively). Mississippi has a graduated income tax rate, ranging from 3% to 5%, and Minnesota's graduated tax rate spans from 5.35% to 9.85%.
If you receive student loan forgiveness in Indiana, for example, you can expect to pay $323 in state taxes for $10,000 in debt relief and $646 in state taxes for $20,000 in forgiveness.
County taxes may also apply in some states and can be flat or progressive. For example in Indiana, residents of the capital city of Indianapolis pay 2.02% in Marion County income tax. That means borrowers who receive $10,000 in forgiveness will owe an additional $202 in local income tax, and those who receive $20,000 in debt relief will owe an additional $404. Altogether, this means a borrower in Indiana could owe as much as $1,050 in state and county taxes on forgiven student loans.
There are 28 states, plus Washington, DC, that either have no income tax (and therefore would not tax forgiven student loan debt) or automatically conform with federal law and will not tax this canceled debt, according to Mark Kantrowitz at The College Investor. These include:
Other states that do not automatically conform with the federal provision, like Hawaii, have recently announced that forgiven student loan debt will not be taxed at the state level. Spokespeople in Virginia, Idaho, New York, West Virginia, Pennsylvania and Kentucky also told the Associated Press their states would not tax borrowers on forgiven student debt.
Although California technically could tax forgiven student debt, legislators have stated residents will not be taxed on forgiven student loans. Speaker of the California State Assembly, Anthony Rendon, confirmed in a tweet that the state is ready to take action to prevent Californians from paying taxes on forgiven debt -- and will do so once the details of the federal student loan forgiveness program are finalized.
At this time it's not clear what will happen in states not mentioned, but we'll keep you updated as the situation evolves.
In addition to student loan forgiveness options, you may be eligible for additional tax credits and deductions. Although 2023 tax thresholds have not yet been released, here are some student loan tax breaks that may boost next year's refund or lower your tax bill.
When you make monthly payments to your student loans, that includes your principal payment as well as any accrued interest payments. Whether you have private or federal student loans, the student loan interest deduction lets you reduce your taxable income, depending on how much interest you paid. For 2021, this reduction went up to $2,500 a year.
You're eligible for the deduction if you paid student loan interest in the given tax year and if you meet modified adjusted gross income requirements (your income after eligible taxes and deductions), For 2021, you qualified if your MAGI was less than $70,000 (or $100,000 if married filing jointly). Partial deductions were offered for those with MAGI between $70,000 and $85,000 ($100,000-$170,000 for those who filed jointly).
With federal student loan repayments on pause and interest at 0%, you might not have paid any interest over the past year. That said, you should log into your student loan portal and check form 1098-E for any eligible interest payments.
If eligible, this deduction will lower your taxable income, which could reduce how much you owe the IRS or increase your tax refund. You might even get placed in a lower tax bracket, which could qualify you for other deductions and credits.
The American Opportunity Tax Credit is available for first-time college students during their first four years of higher education. It allows you to claim 100% of the first $2,000 of qualifying education expenses, then 25% on the next $2,000 spent – for a total of up to $2,500. If you're a parent, you can claim the AOTC per eligible student in your household, as long as they're listed as a dependent.
To claim the full credit in 2021, your MAGI must have been $80,000 or less ($160,000 or less for those married filing jointly). If your MAGI was between $80,000 and $90,000 ($160,000 to $180,000 for those filing jointly), you might have qualified for a partial credit.
The AOTC is a refundable credit, which means if it lowers your income tax to less than zero, you might be able to get a refund on your taxes or increase your existing tax refund.
You can earn money back for qualified education expenses through the Lifetime Learning Credit. The LLC can help pay for any level of continuing education courses (undergraduate, graduate and professional degrees). Transportation to college and living expenses are not considered qualifying expenses for the LLC.
Unlike the AOTC, there's no limit to how many years you can claim the credit. You could get up to $2,000 every year or 20% on the first $10,000 of qualified education expenses. The LLC is not refundable, however, which means you can use the credit to lower your tax bill if you have one, but you won't get any of the credit back as a refund.
For 2021, you were eligible for this credit if you had qualifying expenses and your MAGI was less than $59,000 ($118,000 for those married filing jointly). You could also claim a reduced credit if your MAGI was between $59,000 and $69,000 ($118,000 and $138,000 for those married filing jointly).
Note: You cannot claim both the AOTC and the LLC for the same student in the same tax year. If you're eligible for both, the AOTC typically provides a bigger tax break (and can boost your refund).
Normally, if you have federal student loans in default (meaning you're unable to pay what you owe on them for 270 days), your tax refunds can be taken to help cover the balance owed. Since federal student loans were on pause during the 2022 tax season, your federal tax refund was not eligible to be garnished by the government.
It's unclear if this will remain in place for 2023, though with the new payment pause set to expire at the end of 2022, this benefit may expire.
If you're repaying federal student loans and you're on an income-driven repayment plan, your marriage status may impact your payment amount. For instance, if you're married filing jointly, your payments are based on the joint income between you and your spouse. If you're married filing separately, your payments are based on only your income.
If you decide to file separately to lower your monthly IDR plan payment, however, you may miss out on other key tax benefits. For example, you may not be able to take advantage of a lower tax rate extended to married couples filing jointly, nor will you be able to claim increased credit and deduction amounts available if you filing jointly.
The Revised Pay As You Earn, or REPAYE, plan doesn't distinguish between whether you're listed as married filing separately or married filing jointly. Your payments are based on the income of both you and your spouse.