Student loan borrowers who will benefit from $10,000 or $20,000 in canceled debt don’t have to worry about paying any federal taxes, but some states including Massachusetts could end up taxing that windfall.
The Bay State is one of 13 states that may possibly tax discharged student loan debt as income, according to the Tax Foundation.
The tax policy think tank estimates that Massachusetts student loan borrowers who will have $10,000 in canceled debt could pay $500 in state taxes. That could be doubled to $1,000 in state taxes if they’re Pell Grant recipients with $20,000 in discharged debt.
“There are some states with tax implications for student loan debt, and we’re looking right now at 13 states that may tax student loan debt,” Garrett Watson, senior policy analyst at the Tax Foundation, told the Herald on Thursday.
He noted that Massachusetts is on the list, which also includes New York, Pennsylvania, Virginia, Minnesota, Wisconsin and Arkansas.
“These states will have the opportunity to decide if it is taxable,” Watson said. “They’ll have to provide guidance about whether it will be taxable so folks will know what’s going on.”
Before 2021, borrowers would have had a federal tax liability if any debt was forgiven. But under the American Rescue Plan Act, the forgiveness of student loan debt between 2021 and 2025 does not count toward federal taxable income.
Through the American Rescue Plan Act, states have received indirect taxable benefits, helping lead to higher income tax collections.
“This would be on a smaller scale,” Watson said. “But states deciding it’s taxable would get some additional revenue from that.”
Massachusetts allows a deduction on personal income tax relative to college tuition. To be eligible for the deduction, tuition expenses have to exceed 25% of one’s income. The student loan forgiveness plan could end up reducing the number of taxpayers who would qualify for that income tax deduction.
“By forgiving these expenses, I think fewer people will qualify for the tuition deduction,” said Eileen McAnneny, president of the Massachusetts Taxpayers Foundation. “In some way, we might see a slight bump in income tax collections because fewer people will qualify for the deduction.”
Under President Biden’s student loan debt relief plan, borrowers who earn less than $125,000 — or $250,000 for couples who file taxes jointly — will be eligible for a baseline $10,000, and those who received Pell Grants during college will receive up to $20,000 in relief.
The Massachusetts Department of Revenue did not immediately respond to comment on Thursday.
