Awaiting Student Debt Relief In California? Here’s What To Know About Taxes

The Biden Administration has enacted several changes over the past year that address the burden of student debt.

Over 40 million borrowers nationwide are expected to qualify for student debt relief under the Biden administration's recently announced one-time plan. And people who work in public service may also benefit from administrative changes.

All in all, millions of people could see their entire remaining balance cleared out without any tax obligations. But as things stand, if you live in California, you may have to pay state taxes.

Here’s a breakdown of everything you need to know.

Step 1: What Types of Forgiveness Are You Eligible For?

There are three scenarios that might make you eligible for student loan forgiveness.

1. If you have direct federal loans, which are held by the U.S. Department of Education, you might qualify for the Biden administration’s one-time relief if your income for 2020 or 2021 was less than $125,000 (individuals) or less than $250,000 (households). 

   The administration has promised up to $10,000 of forgiveness for all borrowers in this category, and up to $20,000 for borrowers who meet this criteria and who also received Pell Grants.

   Good to know: Most borrowers will have to apply for this relief. It’s unclear when the application will become available but you can sign up for updates here (choose the top option). Education Secretary Miguel Cardona previously said the department would launch the application in “early October” and it’s expected to stay open through December 2023. 
   

2. If you’re signed up for an income-driven repayment (IDR) plan, you may qualify for forgiveness of any remaining loan balance at the end of a 20- or 25-year period. 
   

3. If you work full-time for a qualifying employer, such as a 501(c)(3) nonprofit or government agency, the Public Service Loan Forgiveness (PSLF) Program clears the remaining balance on your direct loans after you make 120 monthly payments. 

   Good to know: If you’re in this category there are new opportunities to qualify, but you must apply by the end of October. More on that here.

Step 2: What Taxes Apply To You?

Step 3: What's In The Fine Print?

Now through December 2025, the IRS won’t count any discharged student debt as taxable income at the federal level, as stipulated in the American Rescue Plan Act of 2021.

As referenced in the chart above, student debt discharged through the IDR plans or the PSLF program does not count as taxable income in California. We confirmed this with California Tax Franchise Board spokesperson Andrew LePage.

However, there are some important caveats. Stay with us, this gets complicated.

You might fall into more than one category:

• For example, if you’ve been making IDR or PSLF payments for years and have gotten your balance down to $10,000, this amount could be discharged through Biden’s debt relief. In that case, you could be forced to pay taxes in California.
  
• Or let’s say you were a Pell Grant recipient in college and, since graduating, you’ve been making PSLF or IDR payments and have gotten your balance down to $20,000. The Biden administration’s one-time relief could likewise clear that debt, and then you’d have state tax obligations.  

In fact, an attorney enrolled in the PSLF program filed a lawsuit that sought to block Biden’s plan, claiming that the policy would harm borrowers in states that are poised to tax debt relief. In response, the Biden administration said borrowers will be able to opt out of debt relief and a federal judge ruled against the plaintiff. For now, you can still opt out of the $10,000 to $20,000 one-time relief if you want to avoid state taxes.

You may have to fill out an application, but not everyone will.

• According to the Department of Education, most borrowers, regardless of what debt relief category you fall into, will only receive forgiveness after submitting an application.
• However, about 8 million borrowers may get relief without applying if your income data is already on file. This includes people who completed a Free Application for Federal Student Aid (FAFSA) for the 2022–23 school year and those enrolled in an IDR plan based on their 2020 or 2021 income.

If the department determines that you qualify for debt relief without having to submit an application, it will send you an email and text message (if you're signed up for text alerts). This will give you the chance to opt out — and avoid paying any state taxes in California if you are eligible for the $10,000 to $20,000 one-time relief.

Step 4: Understanding What Could Change

In the days following Biden’s announcement, several states — including Massachusetts, New York and Virginia — assured their residents that the discharged debt wouldn't be taxed.

The California Franchise Tax Board has maintained that the debt is taxable at the state level in California.

But state lawmakers have promised to keep this from happening.

In September, Assembly Speaker Anthony Rendon and Senate President Pro Tem Toni Atkins pledged to “make the relief tax exempt through immediate action in 2023.”

“Rest assured,” they both tweeted, “one way or another, California will not tax the federal student debt relief.”

Sen. Steve Glazer (D-Contra Costa) said he’ll introduce a bill on the first day of the new legislative session in December to exempt the forgiven debt from state taxes.

“[F]ederal debt relief is targeted at low-income former students,” Glazer said in a statement. “The last thing California should do is saddle people who qualify for [it] with an unexpected tax bill from the state.”

“[W]e need to take up legislation as quickly as possible so that any uncertainty is resolved before people pay their taxes next spring,” he added.

Any bills that are introduced would need to be passed by the state legislature and make it past the governor’s desk (where there’s an option to veto) before going into effect.