Some Hoosiers could see more than $1,000 added to their tax bills next year due to a provision in state law that would treat student loan debt, forgiven under a plan announced recently by President Joe Biden to fulfill a campaign promise and provide relief to millions of borrowers, as taxable income.
Biden’s plan will forgive up to $20,000 in federal student loan debt for individuals making under $125,000 who qualified for a Pell Grant to help pay for college, generally meaning they were coming from a low-income household. Other borrowers will have up to $10,000 forgiven, provided their annual income is also under the $125,000 threshold.
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More than 900,000 Hoosiers have federal student loan debt. Nearly one-third of them would have all of their federal debt erased under Biden’s forgiveness plan.
For federal purposes, the debt discharged will not be counted toward a taxpayer’s income and many other states have said they’ll follow suit for state and local tax purposes.
That’s not the case in Indiana, though. The Indiana Department of Revenue confirmed that the state will add the debt back into a taxpayer’s income for purposes of paying state and local income taxes. Should forgiveness be completed this year, as is Biden’s plan, Hoosiers would see it show up in next year’s tax bill.
A spokesperson for the Indiana Department of Revenue said that any change would need to be legislatively. At least one lawmaker has said he’ll file a bill to retroactively eliminate and nullify any state individual income tax imposed on Hoosiers who receive federal student loan debt relief.
Language in a 2021 law, though, is the reason that Hoosiers will be taxed in the first place. Last year’s budget bill included language to remove the federal exemption on taxing canceled student loan debt.
House Speaker Todd Huston, R-Fishers, told IndyStar in an email that lawmakers made the change before they knew what federal student loan forgiveness looked like because they wanted to understand the impact it would have before deciding whether to follow the federal government’s lead in making it tax free.
“Moving forward, I expect for conversations to continue on this topic as we head into the next legislative session,” Huston said.
Here’s what you need to know about how, and why, Indiana will tax federal student loan forgiveness:
How much will loan forgiveness add to my state and local tax bill?
Since Indiana’s tax rate is 3.23%, this means Hoosiers will pay $323 in state income tax for each $10,000 in student loan forgiveness. There are also county-level taxes, which vary by county. For example, Marion County’s 2.2% rate would equate to another $202 in taxes for each $10,000 forgiven.
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A Pell Grant recipient that lives in Indianapolis and received the full $20,000 in forgiveness would be on the hook for an additional $1,050 in income taxes.
Why is federal student loan forgiveness being taxed in Indiana?
Generally, debt that is discharged for less than you owe is treated as taxable income. There are exceptions, such as debt discharged through bankruptcy.
When Congress passed the American Rescue Plan Act last year, it included a provision that would exempt student loan debt discharged from 2021 to 2025 from an individual’s taxable income. This essentially set up the framework for Biden to be able to authorize widespread student loan forgiveness and make it tax-free.
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Most states are following the federal government and not counting debt forgiven under the plan as taxable income. It’s common for states to incorporate parts of the federal tax code into their own system of taxation to some degree. How they do so can vary, though, which is why some states are handling loan forgiveness differently.
Some states conform to the Internal Revenue Code on a rolling basis, meaning they automatically adopt changes as they’re made at the federal level. Some are selective, incorporating just a few pieces or definitions but otherwise omitting large swaths in favor of their own policies.
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Indiana conforms on a static basis, meaning it largely conforms to the IRC but only as it reads on a fixed date. This date is routinely updated.
Some states are conforming to a version of the code that pre-dates ARPA, so the provision to exclude student loan debt discharged between 2021 and 2025 from income tax calculations wouldn’t be included and that state would likely be set up to tax loans forgiven under the Biden plan as income. They could choose to update their conformity date or added the exclusion in separately, if they wanted to follow suit with the federal government and make forgiveness tax-free.
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Indiana has conformed to a post-ARPA version of the code but chose to decouple from it on this issue.
The current state budget, passed last year, broke from the federal definition of adjusted gross income for tax purposes on several issues – providing exemptions in some places and adding back in federal exemptions in others. It carved out ARPA’s student loan forgiveness exemption from the state code, setting up Indiana to tax debt discharged under Biden’s plan.
This does not apply to exceptions for certain kinds of student loan debt forgiveness that pre-date ARPA, such as the Public Service Loan Forgiveness program, insolvency or bankruptcy, according to the Indiana Department of Revenue. The department also confirmed that forgiveness resulting from death or total and permanent disability is not taxable.
“In 2021, the federal government made changes to federal tax law to exclude student loan forgiveness as income,” Huston said. “At the same time, it left states in the dark about the potential impact of this change or how it would eventually tie into a future program. Typically, a policy rollout would precede a change in the federal tax code.
“Nearly all of Indiana’s Republican and Democrat legislators decided not to blindly align Indiana’s code with federal code, because we wanted to understand the impact on Hoosier taxpayers and make an informed decision.”
The final version of House Bill 1001, the state budget, did pass with almost unanimous support last year after a last-minute windfall in state tax dollars led lawmakers to make historic investments in the state’s public education system and give teachers long-sought raises.
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Other kinds of debt cancelation could be subject to state taxes, though, such as debt forgiven after a successful Borrower Defense claim. The Biden administration has forgiven billions of dollars in federal student loans taken out by students who attended schools they say defrauded them. This includes high-profile examples such as Corinthian Colleges and Carmel-based ITT Tech. Earlier this year, the federal government canceled all loan debt owed by students who attended either of the now-defunct for-profit institutions.
How many states are taxing debt canceled under Biden’s student loan forgiveness plan?
According to the Tax Foundation, Indiana is one of seven states that is on track to tax the debt discharged under Biden’s student loan forgiveness plan at the state and local level.
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Will I definitely have to pay taxes on my federal student loan debt that gets canceled?
Current law would tax Hoosiers that receive federal student loan debt cancelation. It would take legislative action to change that.
Rep. Greg Porter, D-Indianapolis, said he would file a bill to do just that in the next legislative session. Porter said he’ll draft a bill to “retroactively eliminate and nullify any state individual income tax” imposed on Hoosiers who receive student loan forgiveness.
“Many student borrowers have paid back their original loan amount and then some, but interest rates have kept them from paying off their debt and allocating that money toward buying a house, saving for retirement or starting a family,” Porter said in a statement. “The federal government and the vast majority of other states have correctly chosen not to tax student debt forgiveness. I can’t say I’m surprised Indiana has chosen to take a punitive stance on a policy meant to give working-class Americans relief, but there’s still time to change this.”
Porter said it is unfair to tax student loan debt relief when the state has a $6.1 billion surplus.
The legislative session starts in January. Porter would need Republican support to get the measure passed, as the GOP has a supermajority in both chambers of the Indiana Statehouse. Huston said he expects “conversations to continue on this topic.”
Call IndyStar education reporter Arika Herron at 317-201-5620 or email her at [email protected] Follow her on Twitter: @ArikaHerron.