Here’s how to calculate your bill for student loan forgiveness, if you live in one of the 7 states that may tax it

If you’re expecting relief from President Joe Biden‘s plan to forgive up to $20,000 in student loans, you may have state income tax liability, depending on where you live. 

While legislation is evolving, it’s possible that seven states — Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina and Wisconsin — may tax student loan forgiveness, according to a Tax Foundation analysis. 

It depends on state conformity with federal laws, including the provision from the American Rescue Plan of 2021 that makes student loan forgiveness federally tax-free through 2025. 

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“For the states that don’t conform, things could certainly change,” said Annette Nellen, a CPA and spokesperson for the California Society of Certified Public Accountants. “There’s going to be some pressure.”

While some states charge a flat percentage for income taxes, others have a graduated system, increasing your rate as earnings get higher. 

Generally, state taxes start with your federal taxable income or adjusted gross income, explained certified financial planner Larry Harris, director of tax services at Parsec Financial in Asheville, North Carolina. 

After that, state tax returns apply adjustments or subtractions before multiplying your income by the state’s tax rate, he said.

Of course, you’ll need to include the $10,000 or $20,000 in forgiven student debt as taxable income.

In a flat-tax state, you can multiply the forgiven loan amount by the state’s income tax rate for a quick estimate, Harris said. But it’s trickier in states with graduated rates, he said.

For graduated rates, you can plug 2022 numbers into the computation from your 2021 state tax return for an estimate of where your income may fall, Harris suggested.

“It may not be precise, but it will give you an idea,” he said.

As a general rule, the tax rate only applies to the portion of income which falls into each range. And in some places, you may need to consider local income taxes, too. Here’s a breakdown for each state.

Arkansas

With graduated income tax rates from 2% to 4.9% for 2022, state taxes in Arkansas depend on your earnings, according to a spokesperson for the Arkansas Department of Finance and Administration.

“The taxable amount on $10,000 in student loan relief in Arkansas could range from $200 to $490 depending on overall taxable income,” they said.

California

California residents also have graduated rates based on taxable income, with percentages ranging from 1% to 12.30%, although the higher tiers may exceed the income limits for student loan forgiveness.

“For example, if a single person has taxable income of $40,000, their next dollar of income is taxed at 6%,” Nellen from the California Society of Certified Public Accountants said.

Indiana

Since Indiana has a flat tax rate of 3.23% for 2022, borrowers can multiply that percentage by either $10,000 or $20,000 for an estimated $323 or $646 of state tax liability, a spokesperson for Indiana’s Department of Revenue said. 

However, Indiana residents may also have to pay county tax, depending on their jurisdiction. There’s a breakdown by county here.  

Minnesota

Minnesota’s income tax rates are also graduated, ranging from 5.35% to 9.85% for 2022. The state’s Department of Revenue is working on an example to share with borrowers, according to a spokesperson.

Mississippi

Starting in 2022, there is no state income tax on the first $5,000 of taxable income in Mississippi. However, a flat rate of 5% applies to taxable income over $10,000, according to the Mississippi Society of Certified Public Accountants.

By multiplying 5% by $10,000 or $20,000 of forgiveness, borrowers may estimate $500 or $1,000 of tax liability.

North Carolina

With a flat tax rate of 4.99% for 2022, $10,000 or $20,000 of forgiven debt may trigger tax liability of $499 or $998, respectively, Harris from Parsec Financial said. 

Wisconsin

Another state with graduated rates, possible tax liability in Wisconsin depends on income, with rates ranging from 3.54% to 5.3%.   

For example, a single taxpayer with a taxable income of $50,000 would have a top rate of 5.3%, explained a spokesperson from the Wisconsin Department of Revenue. 

“If they have $10,000 in student loans forgiven, their taxable income would increase by $10,000 and their tax would increase by $530 if they have no credits to apply against their liability,” they said.

If you’re living in a state that may tax student loan forgiveness, you should “be prepared” and try to set the money aside, suggested CFP Ethan Miller, founder of Planning for Progress, specializing in student loans in the Washington, D.C., area.

Worst-case scenario: If you save up the money and student loan forgiveness isn’t taxable in your state, you’ll have extra savings, he said. ”It’s better to be safe than sorry,” Miller added.