President Joe Biden announced in August 2022 that the U.S. government will forgive federal loan debt of up to $10,000 for individuals making less than $125,000 a year.
However, the Indiana Department of Revenue has confirmed they will be taxing student loan debt into a taxpayer’s income to pay state and local income taxes.
Indiana is one out of seven states that is on track to tax the debt discharged under Biden’s student loan forgiveness plan at the state and local level. If the forgiveness plan goes accordingly to Biden’s plan, Indiana residents will see this added tax in next year’s tax bill.
There are specific exceptions for some types of student loan debt forgiveness, including any loan forgiveness resulting from death or total and permanent disability. These exceptions cannot be taxed.
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Indiana’s tax rate is 3.23%, meaning Indiana residents will pay $323 in state income tax for each $10,000 of student loan forgiveness. This does not include county level taxes which will be added on top of that.
The Monroe County tax rate is 1.35%, which adds $135 for each $10,000 of student loan forgiveness.
Last year, Congress passed the American Rescue Plan Act which included a provision that would exempt student loan debt removed from 2021-2025 from being taxed. This helped set up the framework for Biden authorizing tax-free student loan forgiveness.
Regardless of the act, states can incorporate parts of the federal tax code into their own taxation system to a certain extent. This means they can automatically adopt changes as they are made at the federal level.
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States like Indiana follow a static basis which means they mostly follow the Internal Revenue Code, but only as it reads on a fixed date, with the date being routinely updated.
There are also some states that follow a version of the code before the American Rescue Plan Act, which allows student loan forgiveness to be taxed. Those states do have the ability to change and add the exclusions separately or decide to follow the updated version to make the loan forgiveness tax free. Even though Indiana has followed a post-American Rescue Plan Act version of the code, they have chosen to separate from the act on this issue.
The current state budget, which was passed last year, broke from the federal definition of adjusted gross income on several issues for tax purposes. This paved the way for the American Rescue Plan Act’s student loan forgiveness provision being exempt from the state code.
