Will California Tax Student Loan Forgiveness? Everything Borrowers Need to Know

Disclaimer: We are not qualified legal or tax professionals and are not giving advice. Always speak with a qualified professional before making any legal or financial decisions.



In recent developments, Californians facing the burden of student loans have received welcome news. With the Biden administration's push for widespread student loan forgiveness, many borrowers have been anxiously awaiting details on how this federal relief translates at the state level.

This post sheds light on California's stance, highlighting the pivotal legislation signed by Governor Gavin Newsom that exempts forgiven student loans from state income tax, a move echoing the federal government's tax exemption under the American Rescue Plan Act.

Stay informed on what this means for your finances as we break down the essentials of navigating student loan forgiveness in the Golden State.

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Federal Tax Treatment of Student Loan Forgiveness

In August 2022, President Biden announced a broad federal student loan forgiveness program that could provide relief for millions of borrowers. This program promises to cancel up to $10,000 in federal student loan debt for individual borrowers making less than $125,000 per year, or up to $20,000 for Pell Grant recipients within the same income bracket.

This forgiveness applies to loans held by the Department of Education, including Direct Loans, PLUS Loans, and even some FFEL and Perkins Loans. Consolidation loans are also eligible as long as all underlying loans meet program criteria. The White House estimates that nearly 20 million borrowers could see their entire remaining federal student loan balances erased.

Overview of the American Rescue Plan Act (ARPA)

Importantly, the American Rescue Plan Act (ARPA) passed in March 2021 included a provision to make all student loan forgiveness tax-free at the federal level through 2025. Section 9675 of ARPA amended the tax code to exclude canceled and student loan debt forgiveness and debt through the end of 2025 from being counted as gross income for federal tax purposes.

This was a crucial component enabling President Biden's broad loan forgiveness, shielding recipients from a heavy tax burden. Without the ARPA exemption, borrowers whose loans were forgiven could have faced thousands of dollars in federal taxes on the canceled debt depending on their tax bracket.

Many States Follow Federal Tax Exemption

Since most states base their tax codes on federal rules, they generally adhere to the ARPA exemption as well. Residents in these states will not owe any state-level income taxes on canceled federal student loans through 2025.

However, a handful of states have their tax policies that currently do not align with the federal exemption. This means borrowers in those areas may still get a state tax bill even if their forgiveness is tax-free at the federal level.

What We Know About California's Tax Policy So Far

Currently, California tax law may not fully conform with the federal ARPA exemption that makes student loan forgiveness tax-free through 2025. This is because California state's tax code full conformity date is January 1, 2015, before when the new federal rules went into effect.

Under the state's existing laws, canceled student loan debt may count as federal taxable income only. This means California residents who have their federal student loans forgiven could face state income taxes on that relief.

Calls for California to Match Federal Exemption

In September 2022, top state legislators including Assembly Speaker Anthony Rendon and Senate President Pro Tem Toni Atkins released a joint statement calling for quick action to align California's tax code with the federal forgiveness exemption.

They pledged to "make the relief tax exempt through immediate action in early 2023” and ensure residents would not face state taxes on discharged federal student loans.

Bill Introduced to Exclude Forgiveness from State Income

In line with those calls, California Assembly member Phillip Chen introduced AB-113 in December 2022. This legislation would specifically exclude student loan forgiveness from state income taxes through the tax year 2026 if passed.

The status of this bill and whether it ultimately gets approved will determine if California decides to pay state taxes to match the federal tax-free treatment of canceled student debt. We expect to gain more clarity by Fall 2023 at the latest.

In the next sections, we will cover student loan borrowers while California's policy remains unsettled, as well as address some common questions around the issue.

Steps Borrowers Can Take To Prepare

While the outcome of California's policy on taxing student loan forgiveness remains uncertain, there are a few smart steps borrowers can take to get prepared.

1. Estimate Your Potential State Tax Liability

Use online tax calculators to estimate what you might owe California if your forgiven federal student loans are taxed.

Plug in details like your income, filing status, student loan cancellation amount, and other deductions to model different scenarios. This can give you an idea of the possible state tax impact.

2. Set Aside Funds to Cover Additional Taxes

If you determine you might owe extra state taxes on canceled student debt, start setting aside money to cover that additional liability. Automate transfers from each paycheck into a separate savings account so the funds accumulate by tax time.

3. Consult a Tax Professional

Speaking with a tax adviser can provide guidance tailored to your unique financial situation. They can walk through state-specific issues, advise on the best way to prepare, and answer any other questions you might have.

4. Monitor California's Student Loan Tax Policy

Stay up to date on whether proposed legislation progresses to exempt loan forgiveness from state income tax in California. Reaching out to elected representatives to share your perspective may also influence outcomes.

Following these tips can put borrowers in the best position to navigate California's unfolding policy on taxation of student debt relief. We'll now dive into some unresolved questions.

Will California's Proposed Forgiveness Tax Exemption Bill Pass?

The newly introduced AB-113 legislation would specifically exclude discharged federal student loans from state income tax through 2026. However, it remains to be seen whether this bill will make it through committees and secure enough votes from state lawmakers to get approved.

Supporters make a reasonable case that conforming to California's tax treatment prevents penalizing residents who accept loan relief. However the projected $1.8 billion per year in related revenue is not insignificant, so opposition exists based on budget impact.

Could Regulators Act Without Legislation?

Some analysts argue existing state laws might even give California tax authorities enough flexibility to make exempt student debt forgiveness and loan forgiveness without requiring new legislation. However, so far regulators have not publicly taken this stance. Most observers thus expect legislative action to be necessary to provide taxpayer certainty.

The coming year should bring many of these outstanding issues into focus as California solidifies its approach to handling the taxation of unprecedented federal student debt relief, initiated by the Biden administration.

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