Student Debt Relief Plan Could Result in State Income Tax Liability in Some States

(Parker Tax Publishing September 2022)

The U.S. Department of Education provided details on its website regarding President Biden's executive order cancelling up to $20,000 in debt owed by Pell Grant recipients with student loans held by the Department of Education and up to $10,000 in debt owed by non-Pell Grant recipients. Although the American Rescue Plan Act of 2021 (ARPA) generally excludes income from cancelled student loans from gross income for discharges in 2021 through 2025, such relief may be subject to state income taxes in states that do not conform to the ARPA's tax provisions.

Background

On August 24, 2022, President Biden announced a three-part student debt relief plan providing (1) a final extension of the COVID-19 relief for federal student loan repayments through December 31, 2022, (2) up to $20,000 in debt relief for certain borrowers, and (3) proposed rules to make the student loan system more manageable for current and future borrowers, including a cap of 5 percent of monthly discretionary income for income-driven repayment plans.

The debt-relief portion of the plan calls for up to $20,000 in debt cancellation to federal Pell Grant recipients with loans held by the Department of Education and up to $10,000 in debt cancellation to non-Pell Grant recipients. Borrowers are eligible for this relief if their income is less than $125,000 for individuals or $250,000 for married couples or heads of households.

The following types of federal student loans with an outstanding balance as of June 30, 2022, are eligible for relief:

(1) William D. Ford Federal Direct Loan Program loans, including subsidized, unsubsidized, parent PLUS, and graduate PLUS loans;

(2) Federal Family Education Loan Program loans held by the Department of Education or in default at a guaranty agency;

(3) Federal Perkins Loan Program loans held by the Department of Education; and

(4) Defaulted loans, including Department of Education-held or commercially serviced subsidized Stafford, unsubsidized Stafford, parent PLUS, and graduate PLUS, and Perkins loans held by the Department of Education.

Observation: The Department of Education states that nearly 8 million borrowers may be eligible to receive debt relief automatically because it already has access to the relevant income data. If the Department of Education does not have a borrower's income data, an online application will be available by early October. Although 8 million borrowers will receive relief automatically, all eligible borrowers are encouraged to file the application before November 15th in order to receive relief before the payment pause expires on December 31, 2022. The deadline to apply for relief is December 31, 2023.

In addition, borrowers who are employed by non-profits, the military, or federal, state, Tribal, or local government may be eligible to have all of their student loans forgiven through the Public Service Loan Forgiveness (PSLF) program. This is due to temporary changes that waive certain eligibility criteria in the PSLF program. These temporary changes expire on October 31, 2022.

Tax Implications of Student Debt Relief

The American Rescue Plan Act of 2021 (Pub. L. 117-2) amended Code Sec. 108 in order to provide that discharges of federal loans provided for postsecondary educational expenses occurring after December 31, 2020, and before January 1, 2026, are excluded from gross income. Thus, this one-time student loan debt relief announced by President Biden will not be subject to federal income tax as a result of the special exclusion in Code Sec. 108(f)(5). However, in states that do not conform to this provision in the federal tax code, student debt relief could be subject to state income tax. According to the Tax Foundation, these states currently include Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina, and Wisconsin (a list that could change as a result of state level administrative or legislative actions).

Compliance Tip: In Notice 2022-1, the IRS directed lenders or servicers of student loans not to file Forms 1099-C, Cancellation of Debt, to report the discharge of student loans when the discharge is excluded from gross income under Code Sec. 180(f)(5). Thus, borrowers who are on the hook for state income taxes may be required to report the debt cancellation as income on their state income tax returns, even though they will not be receiving a Form 1099-C reporting the amount of the cancelled debt.

For a discussion of the taxation of cancellation of debt income and exceptions to the discharge of indebtedness rule, see Parker Tax ¶72,315.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com