Student record

Californians may have to pay taxes on canceled student loans

Millions of Californians received a long-awaited financial boost last month when the Biden administration announced it would forgive up to $20,000 in federal student debt for low- and middle-income borrowers.

But California tax policy could throw a wet blanket on the party. This is because loan forgiveness may be taxable under current state rules, even though it is tax-exempt under federal law.

Two senior state officials pledged on Friday to fix the problem quickly and ensure that borrowers pay no tax on their debt relief.

Federal and state tax laws generally classify all canceled debt as income, unless the borrowers are bankrupt. There are multiple exceptions, however, and the federal government added another in the US Bailout Act of 2021. This act exempted student loans (and parent loans) canceled by the end of 2025.

California, however, has not changed its tax laws to comply with this provision, said Kathryn Zdan, editorial director of Spidell Publishing, in a podcast last week. So unless you qualify for one of the few exceptions, you may have to treat the amount of debt forgiven under the new Biden initiative as income subject to state taxes.

Ouch.

The Franchise Tax Board is not yet offering clear guidance on the matter, essentially telling borrowers to stay tuned.

“To answer your question about whether the canceled federal student loan debt announced last month will be taxable to California, we would need to know whether the U.S. Department of Education will administer the program under Section 1098e of Title 20 of the United States Code, or use another method,” the council said in an emailed statement.

If the debt is canceled through another section of the law, the council said, it will be taxable in California.

Section 1098e of Title 20 governs the Department of Education’s income-based loan repayment plans, which cancel a borrower’s remaining debt after a maximum of 25 years of monthly payments. Under state law, student loan debt canceled in this manner is not taxable in California.

The Federal Ministry of Education itself remains mum on the matter, saying more details will be forthcoming. Borrowers should keep an eye on the department’s loan forgiveness page and sign up to receive text updates.

Several tax and student loan experts said they were skeptical of the California tax exemption.

The nonprofit Tax Foundation has stated categorically that state exemptions would not apply in this case. Mike Pierce, executive director of the Student Borrower Protection Center, said in an email that “mechanically the release of these loans will not be through income-based repayment.”

John Brooks, a Fordham University law school professor who specializes in student loan issues, agreed. “To be clear, this $10,000/$20,000 debt write-off is not is done under 1098e or one of the [income-driven repayment] provisions,” Brooks said in an email. So far, he added, the department “doesn’t even cite the Higher Education Act at all and instead uses the provisions of the HEROES Act of 2003.”

The state exempts canceled debts from income tax for residents who are insolvent or bankrupt, or for borrowers who complete income-based repayment plans, who die or become disabled, or who qualify of a public service loan. The general pardon of the Biden administration does not fit any of these categories.

Responding to an earlier version of this article, State Assembly Speaker Anthony Rendon (D-Lakewood) and Senate Pro Tem Speaker Toni Atkins (D-San Diego) tweeted“Once the federal government finalizes the details of the student debt relief program, we will know if the relief is tax-exempt under current California law. If not, we will make the relief tax-exempt through immediate action in early 2023. Rest assured, one way or another, California will not impose federal student debt relief.

Either way, the federal government won’t help states like California collect taxes on canceled loans, Brooks said.

“The IRS ordered [the Education Department] and other loan holders not to issue 1099s to borrowers with canceled debt,” Brooks said, referring to an IRS form that reports income received by a taxpayer. “That means it can be difficult for California and other states to enforce this – I suspect many borrowers won’t even realize there’s a tax problem here if they don’t get a 1099.”

If you owe taxes on the forgiven amount, the amount you owe will depend on your income when the debt is forgiven. According to Natalia Abrams, president of the Student Debt Crisis Center, the Department of Education told borrowers that the discount would be implemented by the end of this year.

The administration plans to forgive up to $10,000 in federal student loan debt for single borrowers earning less than $125,000 a year or couples earning less than $250,000. The amount would increase to $20,000 for borrowers who have received Pell Grants and meet income limits.

For single people earning less than $125,000, state tax rates for 2021 started at 1% (for people with up to $9,325 in taxable income) and increased to 9.3% ( for amounts over $61,215). For couples filing jointly, the thresholds for each bracket were double the amounts for single taxpayers.

The brackets will change for 2022 due to inflation. Still, a single taxpayer earning the Los Angeles County median income — about $64,000 — could expect to pay about $800 in taxes on $10,000 of loan forgiveness and about $1,600 on $20,000 of loan forgiveness. loan forgiveness.

For many California borrowers, the amount saved through the loan forgiveness program will far exceed any state taxes they may have to pay. But borrowers in income-based repayment plans can pay as little as $0 per month if their income is low enough. The same is true for borrowers under the Civil Service Loan Forgiveness Program, who could potentially pay more tax on the amount forgiven than they would save in monthly installments. Borrowers in these scenarios may want to forgo debt relief to avoid the tax bill.

It is unclear, however, whether they will have a choice. The Department of Education said it would automatically grant debt relief to around 8 million qualified borrowers whose income data is recorded, with the rest having to apply for loan forgiveness.

It’s also possible that the state will exempt the new round of debt relief before taxes are due, as Rendon and Atkins pledged on Friday. A number of states have already brought their tax laws into line with the federal rules, which means their residents will not pay federal or state taxes on their canceled loans.

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