By Owen Giordano
This summer, President Biden’s administration announced that low- and middle-income individuals who have unpaid student loan debt could have $10,000 of said debt cancelled through the American Rescue Act.[1] While this development is a welcome change to many, only half the battle has been won. There is presently disparate treatment of such relief for income tax purposes amongst the states. Specifically, there are several states that, at present, would treat the debt forgiveness as income.
Forgiven student debts are considered discharge of indebtedness and are thus taxable under federal tax law.[2] However, under the American Rescue Act of 2021, there is a provision excluding forgiven student debts from federal taxation until 2025.[3] This decision provides even more breathing room for the low and middle-income individuals. In theory, this discharge of indebtedness should go untaxed even at the state level given that most states’ tax codes “conform” (follow) to the current federal tax code’s definition of adjusted gross income, which allows for “rolling conformity.”[4]
Most states, such as Virginia and New York, conform to the federal tax code, and thus exempt the relief from taxation—others do not.[5] Some states, such as Indiana, North Carolina, and Mississippi have not adopted the “rolling conformity” language for defining adjusted gross income.[6] This means that such states would tax the relief should it be authorized by state statute. Even more critical is the fact that California, a state home to over 10 million individuals with college degrees, has yet to give a definitive answer as to whether their own tax code allows for the forgiveness to go untaxed.[7] Wisconsin and Arkansas are also in a similar position like California given their nonconformity with the federal tax code.[8] As such, millions of individuals across these states could end up paying income tax on relief that was designed to go untaxed.[9]
This leaves the dissenting states at an impasse. While they are able to tax the relief, whether or not they choose to is left to their discretion. As such, the question becomes how such states can choose to act.
Should such states choose not to tax the relief, a potential solution would be for such states to adopt the current federal definition of adjusted gross income, and thus be able to use the “rolling conformity” language. However, that would require legislative action, which is neither speedy nor guaranteed.[10] Complicating matters further is that many states that do not conform to the federal tax code have legislatures that, currently, would likely not support additional tax exemptions.[11] As such, it is unlikely that is option is viable.
Another option would be for the state’s executive office to issue orders for their state tax department to not collect tax obligations.[12] While this would likely be a speedier option, given that the usual legislative requirements would be overridden, it is again not guaranteed. Specifically, the main issues are the potential difference in views between incumbent executive office and those most likely to benefit from the exemption, as well as the potential lack of constitutional or statutory authority that would authorize the executive office from doing so.[13]
A final option would be for the states’ tax departments to simply limit their enforcement when it comes to reporting this kind of income via their own discretion.[14] Through this method, the hurdles involved in drafting legislation and executive orders would be avoided, as publication of informal guidance is all that is needed. There is also a logistical argument behind this as well, in that the limited resources that all state tax departments have could be put to better use by enforcing more salient and pernicious issues then the discharge of indebtedness.[15] Furthermore, it is unlikely that a legal challenge would arise in the state’s taxation department’s decision to not enforce the tax due to standing issues.[16]
Ultimately, there are multiple avenues for citizens of these select states to help stop the state level taxation of the discharge of student debt. With the Biden administration’s plan still in its infancy, it will be an interesting gauge how the select states that treat such relief as taxable will go forth in the future when it comes to enforcing such tax (if at all).
[1] Press Release, President Biden Administration, FACT SHEET: President Biden Announces Student Loan Relief for Borrowers Who Need It Most (Aug. 24, 2022), https://www.whitehouse.gov/briefing-room/statements-releases/2022/08/24/fact-sheet-president-biden-announces-student-loan-relief-for-borrowers-who-need-it-most/.
[2] 26 I.R.C. 108(f) (2020).
[3] 26 I.R.C. 108(f)(5) (2022); American Rescue Plan Act of 2021, Pub. L. No. 117-2, 135 Stat. 185-186.
[4] Nikhita Airi & Lillian Hunter, Which States Tax Student Loan Forgiveness, and Why Is It So Complicated?, Tax Pol’y Ctr. (Sept. 15, 2022), https://www.taxpolicycenter.org/taxvox/which-states-tax-student-loan-forgiveness-and-why-it-so-complicated.
[5] Nikhita Airi & Lillian Hunter, Which States Tax Student Loan Forgiveness, and Why Is It So Complicated?, Tax Pol’y Ctr. (Sept. 15, 2022), https://www.taxpolicycenter.org/taxvox/which-states-tax-student-loan-forgiveness-and-why-it-so-complicated.
[6] Elaine S. Povich, Some States Could Tax Forgiven Student Loan Debt, PEW (Sept. 8, 2022), https://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2022/09/08/some-states-could-tax-forgiven-student-loan-debt#:~:text=Six%20states%20%E2%80%94%20Hawaii%2C%20Kentucky%2C,a%20compilation%20forwarded%20to%20Stateline; Student Loan Forgiveness Currently Considered Taxable Income, N.C. Dep’t of Rev (Aug. 31, 2022). https://www.ncdor.gov/news/press-releases/2022/08/31/student-loan-forgiveness-currently-considered-taxable-income; Angelica Serrano-Roman, Mississippi Will Tax Forgiven Student Debt in a Departure From Other States, Bloomberg (Aug. 30, 2022), https://www.bloomberg.com/news/articles/2022-08-30/mississippi-in-a-departure-to-tax-forgiven-student-debt.
[7] See S1501 EDUCATIONAL ATTAINMENT for California in 2021, U.S. Census Bureau, https://data.census.gov/cedsci/table?t=Educational%20Attainment&g=0400000US06&y=2021&tid=ACSST1Y2021.S1501 (last visited Nov. 9, 2022); see also Jessica Bryant, The Most Highly Educated States in the U.S., Best College, https://www.bestcolleges.com/news/analysis/2022/01/10/most-highly-educated-states/ (last updated May 6, 2022).
[8] Nikhita Airi & Lillian Hunter, Which States Tax Student Loan Forgiveness, and Why Is It So Complicated?, Tax Pol’y Ctr. (Sept. 15, 2022), https://www.taxpolicycenter.org/taxvox/which-states-tax-student-loan-forgiveness-and-why-it-so-complicated; DFA Statement Regarding Student Loan Forgiveness, Ark. Dep’t of Fin. And Admin. (Sept. 9, 2022), https://www.dfa.arkansas.gov/news/details/dfa-statement-regarding-student-loan-forgiveness.
[9] Nikhita Airi & Lillian Hunter, Which States Tax Student Loan Forgiveness, and Why Is It So Complicated?, Tax Pol’y Ctr. (Sept. 15, 2022), https://www.taxpolicycenter.org/taxvox/which-states-tax-student-loan-forgiveness-and-why-it-so-complicated; Jessica Bryant, The Most Highly Educated States in the U.S., Best College, https://www.bestcolleges.com/news/analysis/2022/01/10/most-highly-educated-states/ (last updated May 6, 2022).
[10] Nikhita Airi & Lillian Hunter, Which States Tax Student Loan Forgiveness, and Why Is It So Complicated?, Tax Pol’y Ctr. (Sept. 15, 2022), https://www.taxpolicycenter.org/taxvox/which-states-tax-student-loan-forgiveness-and-why-it-so-complicated.
[11] Kelly Meyerhofer, Wisconsin Borrowers: Prepare to Pay State Income Taxes on Forgiven Student Loan Debt, Milwaukee J. Sentinel (Aug. 30, 2022), https://www.jsonline.com/story/news/education/2022/08/30/student-loan-forgiveness-plan-may-mean-higher-tax-bill-wisconsin/7904355001/.
[12] Powers and Authorities, Nat’l Gov. Ass’n, https://www.nga.org/governors/powers-and-authority/ (last visited Nov. 9, 2022).
[13] Id.
[14] See David Epstein & Sharyn O’Halloran, Administrative Procedures, Information, and Agency Discretion, 38 Am. J. Pol. Sci. 697, 697 (1994).
[15] See Frequently Asked Questions, Va. Dep’t of Budget and Planning https://dpb.virginia.gov/budget/faq.cfm#wherego (last updated Feb. 2, 2022) (using Virginia’s budget to as an example of the limited resources states have at their disposal).
[16] On the grounds that a taxpayer who doesn’t not have to report income from debt relief likely does not have a “beneficial interest” in having said income taxed. See, e.g. Cal. Civ. Proc. Code § 1086 (West); People ex rel. Dep’t of Conservation v. El Dorado Cnty., 36 Cal. 4th 971, 986 116 P.3d 567, 572 (2005) (for context, this is assuming that other states have similar logic to California’s when it comes to standing for judicial review).