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Welcome federal student debt relief could create some state tax issues

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College can be fun. Paying for it, not so much, especially when you have to take out loans. Some student borrowers are getting loan relief from the White House, but also might end up owing state taxes on their forgiven student debt. (Photo by cottonbro)

Around 20 million folks who borrowed money to attend college got good news last week when President Joe Biden canceled a chunk of their student loan debt.

The Biden plan's major component says that individuals earning less than $125,000 (or $250,000 for married couples or heads of households) a year will be eligible for up to $10,000 in debt cancellation. Pell Grant recipients earning less than $125,000 (or $250,000 for married couples or heads of households) a year are eligible for up to $20,000 in debt reduction.

Note the dollar amount caps. Those up-to amounts might be less, since the forgiveness applies to the amount of outstanding debt. If, for example, you are eligible for $20,000 in debt relief, but have a student loan balance of $15,000 remaining, you will only receive $15,000 in relief.

Still, any amount of debt relief obviously will make a difference in the eligible individuals finances.

It could, however, also produce some unwelcome state tax effects.

Taxing forgiven debt: Generally, tax law says that forgiven debt is taxable income. For example, if you can convince your credit card company to write off $10,000 of your charges, the Internal Revenue Service will consider that 10 grand taxable.

You'll even get an official Form 1099-C, Cancellation of Debt, or acceptable substitute form to let you and the IRS know of the forgiven amount on which you owe tax.

1099-C cancellation of debt revised January 2022
See more tax forms and more about them at Talking Tax Forms.

That's not a problem, however, in the Biden student loan forgiveness plan.

These amounts will not be taxable income as far as Uncle Sam is concerned. The American Rescue Plan Act that became law in March 2021 specified the forgiveness of student loan debt between 2021 and 2025 doesn't count toward federal taxable income.

State tax law matters: But it could be a different tax tale in some states.

That's why this weekend's Saturday Shout Outs go to several blog posts and articles that look at tax implications of the Biden student loan relief plan.

Jared Walczak, title at the Tax Foundation, writes at that Washington, D.C.-based tax policy organization's blog that Thirteen States May Tax Student Loan Debt Cancelation.

I'll let you read his post for details, but here's a preview. If you live in Arkansas, Hawaii, Idaho, Kentucky, Massachusetts, Minnesota, Mississippi, New York, Pennsylvania, South Carolina, Virginia, West Virginia, or Wisconsin, be aware of possible state tax implications.

Kate Dore, personal finance reporter for CNBC, talks with Walczak and offers more on how to know if your debt cancellation will trigger a state tax bill.

Michael J. Bologna and Erin Slowey, reporters at Accounting Today, also write about how Student debt forgiveness may be taxable in more than a dozen states. But, notes the pair, that's "a hiccup many states are expected to quickly handle."

More on the full Biden plan: If you're looking for more the overall Biden student loan relief plan, then head to the White House's online presence. It lays out the plan in a fact sheet.

There's also the Federal Student Aid webpage created by the U.S. Education Department which has plan specifics.

Finally, for all those who've been paying federal student loans during the pandemic, CNBC Select personal finance reporter Brett Holzhauer has information on how you may be able to get a refund of those payments made since March 2020.

And that's enough finance and tax Saturday Shout Out homework for this weekend!

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