The NC Department of Revenue (DOR) recently announced that student loan forgiveness is taxable income for the purposes of state income taxes. This means that borrowers will need to pay state income tax on the amount of their student loans that are forgiven. Legislative leaders have indicated that theydo not anticipate that the NC General Assembly will change this law. The Center has carefully reviewed the federal and state tax codes and determined that – notwithstanding the existing state law and the recent DOR announcement – nonprofit employees who have their student loans forgiven through PSLF will not be liable for paying federal or state income tax on their loan forgiveness.
Even though the current state law appears not to apply to PSLF, the Center supports a change in the law since the current tax on forgiven student loans will result in a tax increase for nonprofit employees – and for many people who receive services from nonprofits – who receive debt cancellation through the new federal program or through an income-based repayment plan.
If you are interested in additional information about the applicable federal and state laws and the Center’s analysis, we are providing a few more details in the next two paragraphs. If excessive legalese makes you squeamish, feel free to skip past these two paragraphs.
As background, a provision of the 2021 American Rescue Act Plan, which has been codified as Section 108(f)(5) of the Internal Revenue Code, excludes student loan forgiveness from income for federal tax purposes. This means that borrowers – including nonprofit employees – who receive loan forgiveness through the certain income-based repayment plans or the new US. Department of Education student debt cancellation program will not need to pay federal income tax on the amount of their student loans that are forgiven. The federal income tax exclusion applies to loan forgiveness between 2021 and 2025. Last year, the NC General Assembly chose to “decouple’ from this federal income tax exclusion, meaning borrowers who receive loan forgiveness need to add the amount of loans that were forgiven to their taxable income for the purpose of state income taxes. Unless the NC General Assembly changes this law, North Carolina will be one of only seven states to tax borrowers’ this student loan forgiveness.
The Center’s analysis, however, found that borrowers who have their student loan forgiven under PSLF can have the amounts of their PSLF loan forgiveness excluded from income for the purpose of federal income taxes under a different subsection of the Internal Revenue Code (Section 108(f)(1)). This subsection excludes from gross income “any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of any student loan if such discharge was pursuant to a provision of such loan under which all or part of the indebtedness of the individual would be discharged if the individual worked for a certain period of time in certain professions for any of a broad class of employers.” Because the NC General Assembly has not decoupled the state tax code from IRC Section 108(f)(1), the federal income exclusion for certain student loan forgiveness under IRC Section 108(f)(1) also applies to state income tax. Translation: If your student loan was forgiven through PSLF, you shouldn’t have to pay federal or state income tax on the amount of your loan forgiveness.