You may have heard the news – student loan issuance of any kind is now tax free! And you may have always known that some programs like public lending were tax-free, at least at the federal level. But did you know that every state has a different law regarding state taxes on lending?
The American Rescue Plan Act of 2021 added an exclusion from federal income tax returns for student loan issuance through December 31, 2025.
But what about the government’s policy of taxing student loan forgiveness? Some states offer tax-exempt student loan status and some do not. This could be an unexpected tax bomb waiting for some Americans.
While student loan issuance is tax-free nationwide until December 31, 2025, it may not be tax-free at the state level. In fact, prior to the American Rescue Plan Act of 2021, some student loan programs were taxable at the federal level. See this guide on federal taxes and student loan allocation.
Based on our investigation of state tax laws, you may still have to pay a “tax bomb” to your state for student loan issuance. In some states, paying off debts is considered taxable income. For example, if you have been given a $ 10,000 student loan, that amount will be added to your income and you will pay tax on the result.
Right now we see the following:
- 11 countries with no state income tax, so lending is tax-free
- 20 states that automatically adhere to federal tax rules so lending is tax-free
That leaves 19 states where Student loan issuance may or may not be tax-free. In particular, there may be some types and / or timing of lending that may be tax-exempt while other forms and / or timing may not.
For example, Virginia excludes full and permanent dismissal from state income tax filing income, but only for veterans and only through 2025.
State taxes and lending make student loan borrowers a messy complication.
Find your state below and see what laws your state follows.
States with no income tax
Nine states offer tax-exempt student loan status because they do not have personal income tax. These states include:
- New Hampshire
- South Dakota
New Hampshire and Tennessee have a tax on interest and dividends but no other income. The Tennessee tax on interest and dividends will also end in 2021.
connected: Ultimate Guide to State Income Taxes
States that automatically comply with federal tax regulations
There are 20 states that base their definition of income on the federal definition of Adjusted Gross Income (AGI) from the amended 1986 Internal Revenue Code and automatically update their definition with changes to federal law.
Accordingly, changes to the federal tax law, such as the new income exclusion for the granting of student loans, automatically affect the state income tax in these federal states. These states include:
- New Mexico
- new York
- Rhode Island
- Washington, DC
Massachusetts and Michigan Use a hybrid approach where taxpayers can choose to use the federal AGI. In addition, Iowa has a deduction for repaying military student loans.
new York does not consider distributions from 529 student loan repayment plans to be eligible. New York has an explicit subtraction for death and disability layoffs from student loans.
Three states base their definition of income on the federal definition of taxable income instead of AGI and update their definition automatically with changes to federal law. These states are Colorado, North Dakota and Oregon.
States that comply with federal tax regulations at any given time
There are several states that must pass laws to incorporate changes to the 1986 Internal Revenue Code (IRC). Not all will.
Even if so, state laws can delay changes to federal law for a year or more. One has to compare the date of the version of the IRC on which the state tax law is based to the date the tax-exempt status was enacted for various student loan grants and reliefs.
In fact, these states have decoupled their definition of income from the federal definition of income. Accordingly, these states do not automatically include the Income Exclusion for Student Loans under the American Rescue Plan Act of 2021.
Student loan issuance may be taxable in these states depending on when you receive student loan issuance and when the state changes the law.
States that match the federal definition of “AGI” on a particular date
There are 11 states whose definition of income is based on the federal definition of Adjusted Gross Income (AGI) on a given date. These states are:
- North Carolina
- West Virginia
California provides the borrower with tax-exempt status for repayment and relief from closed schools through December 1, 2024. California also offers tax-exempt status for layoffs of death and disability through January 1, 2026. Government loan issuance is in California tax exempt.
Maine offers a state income tax credit, Opportunity Maine Tax Credit, to reimburse student loan payments for recent college graduates who live and work in Maine. Maine also offers a deduction for student loan payments made by the borrower’s employer under the Maine Educational Opportunity Program (FAQ).
Employer Student Loan Repayment Assistance Programs (LRAPs) are taxable in North Carolina in 2020.
Virginia This does not include full and permanent federal income tax release income, but only for veterans and only through 2025. Virginia offers an income deduction for student loan layoffs due to student death. It does not apply to private student loan relief. This may have been replaced by changes to the federal tax law.
Arizona, Virginia and Wisconsin You have no income mark-up for student loan and other student loan relief.
States that match the federal definition of “taxable income” at a given point in time
Three states base their definition of income on the federal definition of taxable income instead of the AGI at a given point in time. These states are Idaho, Minnesota and South carolina.
Minnesota generally complies with Federal Law on Taxation of Student Loans. Minnesota has a deduction for forgiveness after 20 or 25 years in an earnings-based repayment plan and for forgiveness for teacher shortages in Minnesota. Minnesota offers a non-refundable student loan loan for payments on qualified student loans.
This table shows the effective dates of amendments to the Internal Revenue Code of 1986 or the Higher Education Act of 1965 to exclude certain types of student loan issuance from income. Comparing the date of the version of the IRC that the state adheres to these dates can give an indication of whether any type of lending is tax-free.
States that do not base their income on federal tax regulations
Five states base their definition of income on their own definition of gross income. These states do not correspond to the federal definition of income. Changes in the federal definition of income do not affect these states.
The Income Exclusion for Student Loan Forgiveness under the American Rescue Plan Act of 2021 Not apply to these states. These states must pass laws to exclude student loan granting from income. Accordingly, student loan issuance may be taxable in these states.
These states are:
- New Jersey
Arkansas has a deduction for interest paid on qualified educational loans. New Jersey has an income exclusion for debt relief.
Pennsylvania Student loan tax forgiveness for working in certain occupations. Therefore, government loans and teacher loans are taxable in Pennsylvania. Employer-paid student loan repayment programs (LRAPs) are taxable in Pennsylvania. Debt relief is taxable in Pennsylvania unless specifically excluded from taxable income.
Disclaimer of liability
This article was based on a review of state income tax forms and state law.
No claims are made as to the accuracy, timeliness, or usefulness of the information provided in this article. The information described in this article is subject to change.
This article does not provide legal, financial, or tax advice. This information is of a general nature and may not apply to the particular circumstances of individual readers.
Readers should seek advice directly from a qualified accountant or tax advisor in their country. This article is not intended as a substitute for professional advice.