State might tax canceled student loan debt

Arkansas is one of seven states in which canceled student loan debt may be treated as taxable income, but whether it is, student loan forgiveness is expected to create a tax burden shift from the borrowers.

Recently, President Joe Biden announced plans to cancel up to $20,000 in student loan debt, depending on borrowers’ income. Pell Grant recipients qualify for up to the total amount in relief, while other borrowers can cancel up to $10,000 in student loan debt. Eligible borrowers must have an annual income of less than $125,000 or $250,000 for married couples or heads of households.

According to Federal Student Aid, an office of the U.S. Department of Education, nearly 8 million borrowers may be eligible for relief automatically because the agency already has relevant income data. By early October, an online application is expected to become available at studentaid.gov, allowing borrowers to apply for the relief. The application deadline will be Dec. 31, 2023.

CPA Melania Powell, a tax partner for HoganTaylor LLP in Fayetteville, said Arkansas borrowers will need to report canceled student loan debt on their state income tax return as it is taxable income.

However, Powell and other CPAs are awaiting guidance on how it will be reported with the canceled debt tax-exempt under federal law and that the IRS directed student loan companies to stop providing borrowers the tax documents showing the canceled debt.

“How it’s going to be reported is going to be interesting because, for federal law, they did away with having to do a 1099-C for that,” she said. “There’s not anything that’s going to be reported to [borrowers], so they’re going to have to pay attention and pick it up on their tax return for Arkansas.

“It poses an interesting question: ‘How’s the state even going to know what they were forgiven?’ Generally, you run off federal forms for those things.”

An extra layer of uncertainty was added Thursday (Sept. 29) when Arkansas Attorney General Leslie Rutledge announced a lawsuit against President Biden, Secretary of Education Miguel Cardona and the U.S. Department of Education. The lawsuit claims the student loan debt plan violates federal law.

‘ROLLING CONFORMITY’
Asked what makes Arkansas unique compared to the 43 states in which the canceled debt is not taxable, Powell said the “other states have what they call rolling conformity. That means as the federal tax code changes, they agree to it.”

Powell said Arkansas conforms to some segments of federal tax law, but it does not on canceled student loan debt. She noted that Arkansas conformed when it came to pandemic-related relief.

CPA Randy Ponce, president of Sonia’s Tax Service in Springdale, said the government approved unemployment tax forgiveness after millions of people had already filed amid tax filing season last year. The state might offer student loan tax forgiveness similarly.

“There may be a situation also where this happens the same way,” Ponce said. “We just won’t know how to treat it to start the tax season.”

However, Powell said she doesn’t think the state will offer tax forgiveness on canceled student loan debt based on Gov. Asa Hutchinson’s recent statement. He called Biden’s student debt relief plans a “misuse of executive authority.”

“Shifting the burden from those who willingly took out a loan to all taxpayers is inconsistent with the American ideal of personal responsibility and will further discourage those who took a different path, including work or lower-cost schools,” Hutchinson said. “If President Biden wanted to provide relief to Americans with student loan debts, he could work to permanently lower interest rates instead of across-the-board forgiveness. ‘Forgiving’ student loan debts will reward high-cost schools and add to the inflated cost of higher education.”

STUDENT LOAN FILTER
Biden’s plans for student loan forgiveness are about as favorable at the state’s top office as the words “student loan” are at the Arkansas Department of Finance and Administration. The state agency has been rejecting email messages with those two words.

According to agency spokesman Scott Hardin, the agency’s email filter blocks incoming emails with the words “student loan.” Outgoing messages with those words seem unaffected because Hardin successfully sent an email with his and Hutchinson’s statements on student loan forgiveness. (A reply to Hardin’s email also failed.)

In a prior phone call, Hardin said canceled student loan debt is considered taxable income currently. Still, the state legislature could change this as it did for the pandemic-related relief.

“The Arkansas General Assembly and Gov. Asa Hutchison took action to exempt unemployment payments from state income tax for a two-year period,” Hardin said. “Additionally, PPP loans are not subject to state income tax because of legislation. The General Assembly meets in January and may take similar action to exempt this student debt forgiveness.”

Asked about Hutchinson’s statement on the tax burden shift, Powell said the debt forgiveness won’t have “an immediate direct impact on other taxpayers but will have an impact at some point in the future. There is always the other side of the coin of who ultimately ends up paying for this forgiveness… Eventually, that falls on all taxpayers, even those who haven’t gone to college or had student loans.”

While the debt forgiveness won’t immediately impact taxpayers, Powell said that Congress would have to raise taxes at some point to pay for it. Also, she noted that Hutchinson’s position on student loan forgiveness would be a “little bit of a revenue raise.” She recommended that borrowers check with their lenders to see if they are eligible for the forgiveness.