There has been lots of talk about student loan forgiveness recently, especially after the past two years of Covid chaos which had a negative financial impact on many taxpayers. Now with inflation rising, the government has finally pushed through the American Rescue Plan legislation including student loan debt relief which may help your financial situation as a freelancer. A key caveat: The net benefit of this new legislation may largely depend on where you live, according to how each state enacts it.
Here are the details of how the American Rescue Plan may help individual taxpayers:
In general, debt forgiveness, including student loan forgiveness is considered taxable income at the federal and state level. However, student loan forgiveness under income-driven repayment plans is temporarily exempted from taxable income, if forgiven between 2021 through 2025.
It is important to note that this may not be the case at the state level. In addition, forgiveness only applies to government loans not private ones.
If you as a parent, or your own parents have a Federal Parent Plus loan, it is eligible for forgiveness if the signor’s income is less than the limit of $125,000 for a single filer or $250,000 for a married couple.
Loan forgiveness eligibility for student borrowers claimed as dependents for tax purposes by their parents will depend on the parents’ income.
Beware of a potential student loan relief tax trigger in some states:
On the surface, student loan forgiveness sounds like an easy win for taxpayers. However, even if your federal income tax burden is lowered, you may still have to pay a significant amount of income tax on this forgiveness to your state if it considers it taxable income. This means that if you receive $15,000 in relief, depending on where you live, it may be treated as taxable income at the state level.
Currently, these states have no income tax, so if you live in one of them federal student loan forgiveness would not impact your tax situation:
Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
However, under the current guidance if you live in one of these states (New York State included), you could be liable for state tax on federal student loan forgiveness:
Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia and Wisconsin.
There are several states that automatically conform with federal tax rules. If you live in one of these states benefiting from federal loan forgiveness will not have an impact on your state income tax situation.
How much could your state tax burden be? According to The Tax Foundation, taxpayers in states taxing student loan forgiveness could be on the hook for anywhere from $300 to over $1,000 in state taxes, depending on the specific state, “if they receive $10,000 in student loan forgiveness through the Biden plan. These figures could double for Pell Grant recipients, who are eligible to receive up to $20,000 in student loan forgiveness.”
Watch for updates on how the new student loan forgiveness law will impact you.
There is likely to be additional guidance issued by individual states and potentially the federal government as well related to student debt forgiveness. Unless you are aware of the direct state guidance regarding your residence status it is smart to consult with a tax professional to learn how student loan forgiveness under the new American Rescue Plan will impact your freelance tax situation.
Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.
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