As millions of Americans prepare to submit applications for student loan forgiveness through the Biden administration’s new program, the residents of seven states could get a tax bill if they accept the loan cancellation.
Those states are: Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina and Wisconsin.
The tax provisions are not specifically targeting student loans, but they are part of some state laws broadly regarding debt forgiveness.
As a result, according to Jared Walczak, a vice president at the Tax Foundation, a nonprofit group that supports lower taxes, state legislatures will need to act if they want to avoid penalizing some borrowers for accepting loan forgiveness, which itself could blunt the positive impact the White House had hoped to achieve through the program.
Federal data shows that more than 8 million residents in the seven states could be affected.
California is the largest state currently in line to tax student loan forgiveness. That’s because it has not yet changed its laws to conform to a provision contained in the American Rescue Plan Act of 2021 that exempted student loan cancellation from federal taxation until 2025.
According to a calculation by The Los Angeles Times, a single taxpayer earning the median annual income of about $64,000 in Los Angeles County could get an $800 tax bill for $10,000 in loan forgiveness, and a roughly $1,600 bill if they have $20,000 in loans canceled.
The reason is fairly simple. In most circumstances, having an amount of money that you owe wiped away, meaning you are no longer responsible for paying it back, is considered to be taxable income. That canceled debt is essentially money you can keep in your pocket, rather than having to pay toward the loan bill.
However, California legislators have promised to change the state’s tax code to exempt student debt forgiveness from being taxed. On Sept. 9, California Assembly Speaker Anthony Rendon and Senate President Pro Tem Toni Atkins tweeted they would “make the relief tax exempt through immediate action in early 2023.”
“Rest assured, one way or another, California will not tax the federal student debt relief,” they said.
At least two other states, Minnesota and Wisconsin, have not updated their tax laws to conform with the new federal regulations tied to student debt relief, according to the Tax Foundation. One estimate from Minnesota news station KMSP-TV indicates an individual who has $10,000 in loans forgiven would get a state income tax bill of at least $535.
“If the state does not conform to this federal law, then Minnesota taxpayers who have their student debt discharged will have to add back this amount for Minnesota income tax purposes,” a state department of revenue spokesman told NBC News in an email.
A Wisconsin spokesperson did not respond to a request for comment.
In both those states, legislators have pledged to update tax codes so that debt-forgiveness taxes would not be imposed.
Another Midwest state has already announced it will tax people who accept the debt cancellation. In a statement to NBC News, a spokesperson for the Indiana Department of Revenue confirmed its residents will owe up to $323 for $10,000 in student loan forgiveness and $646 for $20,000 in student loan forgiveness.
Barring a change, two Southern states are also set to tax the student loan discharges: Mississippi and North Carolina. On Sept. 14, North Carolina Gov. Roy Cooper called on legislators to waive that tax.
“Legislative leaders need to find a solution that treats student loan forgiveness the same way they handled the PPP loan forgiveness that many of them received,” Cooper said. “Republican legislators were quick to help businesses and should now fix this fundamental unfairness for many hardworking people who will get hit hard by this.”
On Sept. 2, the nonprofit news website Mississippi Today reported state residents who were eligible for up to $10,000 in student loan forgiveness will see $500 in additional taxes if they accept the loan cancellation. People who are eligible for up to $20,000 in debt relief would be on the hook for as much as $1,000 owed on their state taxes.
Representatives for Mississippi and North Carolina did not respond to requests for comment.
In Arkansas, the Department of Finance and Administration said on Sept. 9 that “it would be inaccurate to report student loan forgiveness will be taxable” there because its legislative session was not yet complete.”
A representative for Arkansas could not be reached for comment.