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

You may be subject to state income tax if you are expecting relief from President Joe Biden’s plan to forgive student loans up to $20,000, depending on where your residence is. 

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 is dependent on compliance by the state with federal laws, including the American Rescue Plan 2021 provision that makes federal student loan forgiveness tax-free until 2025. 

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Annette Nellen (CPA) spoke for the California Society of Certified Public Accountants. She stated, “For the states who don’t comply, things could definitely change.” “There will be some pressure.”

How state income taxes work

While some states charge income taxes at a flat rate, others have a graduated system. As your earnings rise, you will pay more. 

State taxes are generally calculated from your federal taxable income or adjusted Gross Income, explained Larry Harris, certified financial planner and director of tax services at Parsec Financial, Asheville, North Carolina. 

He said that after that, state tax returns apply adjustments and subtractions before multiplying income by the state’s tax rate.

You will need to include $10,000 or $20,000 forgiven student debt in your taxable income.

How to estimate your state’s tax liability

Harris explained that in a state with a flat tax, you can multiply the forgiven amount by the state’s income tax rate to get a quick estimate. He said it’s more complicated in states with graduated tax rates.

Harris suggested that for graduated rates, you can use 2022 numbers in the computation from your 2021 tax return to estimate where your income might fall.

He stated, “It might not be exact, but it will give an idea.”

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How much student loan forgiveness could cost you

The tax rate applies to the income within each range. In some cases, you might need to take into account local income taxes. Here’s a breakdown by state.

Arkansas

According to a spokesperson from the Arkansas Department of Finance and Administration, Arkansas state taxes are based on your earnings. They have graduated income tax rates ranging from 2% to 4.9% in 2022.

“The taxable amount for $10,000 in Arkansas student loan relief could range from $200 up to $490 depending upon overall taxable earnings,” they stated.

California

San Francisco

Getty Images| Getty Images

California residents also have graduated ratesThe percentages are based on taxable earnings, and can range from 1% up to 12.30%. However higher income levels may not allow for student loan forgiveness.

Nellen, from the California Society of Certified Public Accountants, stated that if a single person has $40,000 in taxable income, their next dollar of income will be taxed at 6 percent.

Indiana

Indiana has a flat tax rate 3.23%A spokesperson for Indiana’s Department of Revenue stated that borrowers can multiply this percentage by $10,000 or $20,000 to get an estimated $323 or $646 of state taxes liability for 2022. 

However, Indiana residents may have to pay county taxes depending on where they live. Below is a breakdown by county here.  

Minnesota

Minnesota’s income tax ratesThey are also graduated and range from 5.35% to 9.85% in 2022. A spokesperson for the Department of Revenue said that they are working on an example to share to borrowers.

Mississippi

Beginning in 2022, Mississippi will no longer impose a state income tax on the first $5,000 of income. According to the Mississippi Society of Certified Public Accountants (MSCA), taxable income exceeding $10,000 is subject to a flat rate of 5 percent.

Borrowers can estimate their tax liability by multiplying 5% by $10,000, $20,000 of forgiveness, or $500 to $1,000.

North Carolina

A flat tax rate of 4.99%Harris from Parsec Financial stated that a forgiven $10,000 or $20,000 debt could trigger a tax liability of $499 and $998 for 2022. 

Wisconsin

Farm near Madison Wisconin

E+| E+ | Getty Images

Another state with graduated ratesWisconsin’s tax liability is dependent on your income. Rates can range from 3.54% to 5.3%.   

A spokesperson from the Wisconsin Department of Revenue explained that a single taxpayer earning $50,000 in taxable income would be subject to a maximum rate of 5.3%. 

They said that if they were to forgive $10,000 of student loans, their taxable income will increase by $10,000 and their tax will increase by $530 if no credits are available to offset their liability.

If your state offers tax forgiveness, ‘Be Prepared’

CFP Ethan Miller, founder Planning for Progress, said that if your state may tax student loan forgiveness, it is important to “be prepared” and to try to put the money aside. Planning for Progress specializes in student loans in Washington, D.C.

Worst case scenario: If you have enough money saved up and student loan forgiveness in your state isn’t tax-deductible, you can save more, he said. Miller said, “It’s safer to be safe than sorry.”

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Source: CNBC

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