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Biden's student debt forgiveness may be taxed in these five states

Although student debt discharged is exempt from federal tax due to the American Rescue Plan Act of 2021, some states may still tax the savings, according to a report by the Tax Foundation.

Millions of borrowers may be eligible to receive some student loan forgiveness under President Joe Biden's new income-driven repayment (IDR) plan. Still, according to a recent report, some may face having to pay taxes on these savings.

The Biden administration introduced the Saving on a Valuable Education (SAVE) plan to help student loan borrowers after the Supreme Court's decision to strike down Biden's student loan forgiveness plan

The new IDR plan would reduce the monthly payment to $0 for borrowers earning $32,800 a year or less, translating to roughly $15 an hour, the White House said in a statement

Additionally, borrowers with an original balance of $12,000 or less will receive forgiveness of any remaining balance after making 10 years of payments, with the maximum repayment period before forgiveness rising by one year for every additional $1,000 borrowed.

More than 800,000 Americans with student debt who have been in repayment for over 20 years have already started to see those debts canceled, and the administration estimates that over 20 million borrowers could benefit from the SAVE plan.

Although discharged student debt is exempt from federal tax due to the American Rescue Plan Act of 2021, some states may still tax the savings, according to a report by the Tax Foundation.

As of 2023, Indiana, North Carolina and Mississippi have stated that the balance of forgiven student loans will be taxed as income. Taxpayers in Arkansas and Wisconsin may also have to pay taxes on forgiven student loan debt, but these states are currently reviewing their tax laws and have yet to decide.

If you hold private student loans, you could consider refinancing them to a lower interest rate to reduce your monthly payments. Visit Credible to compare options from different lenders and choose the one with the best rate for you.

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Student loan borrowers that have their debts discharged under Biden's SAVE plan could see the amount of debt forgiveness they receive show up as gross income, according to an Experian blog.

However, according to Experian, a borrower's federal student loan forgiveness balance may add to a tax bill. Still, it may not be enough to push borrowers into a higher tax rate.

"Remember, tax brackets don't work by applying a single tax rate to your entire income; rather, they are tiered," Experian said. "Each tier of your income gets taxed at a slightly higher marginal tax rate." 

If you are currently in school or starting soon and need more financial aid than you can receive through FAFSA, you could consider taking out a private student loan. Visit Credible to find your personalized rate without affecting your credit score.

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A "student loan tax bomb" is when your student loan lender forgives all or a portion of your debt, causing you to include this amount in your taxable income, according to TurboTax.

If your state isn't exempting federal student loan forgiveness from taxes, you will have to calculate your state taxes with the forgiveness factored into your income. 

Once you estimate your tax bill, prioritize saving the money you would have paid toward your forgiven loans, according to TurboTax. This can help you avoid a cash crunch caused by a student debt tax bomb.

"If you set aside $25 per month for 25 years in an account earning 2% compounding interest per year for your eventual tax payment, you'll have saved over $9,000 after taxes (assuming a 22% marginal income tax bracket)," TurboTax said. "This amount can be used to offset your future student loan tax bomb."

If you hold private student loans, you won't be enrolled in a federal income-driven repayment plan, but you could refinance your loans to a lower rate. Visit Credible to compare options from different lenders without affecting your credit score.

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Have a finance-related question, but don't know who to ask? Email The Credible Money Expert at moneyexpert@credible.com and your question might be answered by Credible in our Money Expert column.

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