Minnesota legislators are considering lifting taxes on federal student debt relief

Minnesotans who qualify for student loan forgiveness under President Joe Biden's plan could be in for an unpleasant surprise next tax season.

If Biden's plan remains intact and the Legislature doesn't act, Minnesota borrowers whose debt is erased or reduced will have to pay state income tax on the relief. Some may also find they've been bumped into a higher state tax bracket.

According to the Minnesota Department of Revenue, a former student receiving $10,000 in relief from the federal government could see an associated state tax liability of $500-$800.

Some DFL lawmakers are pressing for a quick Capitol deal to avoid higher taxes for borrowers.

"Bottom line is, it's another reason to have a special session," said House Taxes Committee Chair Paul Marquart, DFL-Dilworth. "Had we passed that tax bill, it would have been solved [and] students wouldn't have to worry about this."

Republican legislators, who aren't fond of Biden's loan forgiveness program, are open to changes in state law. But they're also awaiting word on a possible federal legal challenge that could mean a delay or cancellation of the president's action.

Biden's plan would grant up to $10,000 in relief for individuals earning $125,000 or less annually, or married couples making $250,000. Pell Grant recipients could get up to $20,000 of debt canceled. The loan forgiveness would be federally tax-free through 2025.

The Legislature had a deal to change tax law to match the federal American Rescue Plan Act during the last session, but failed to pass an overall tax bill. That means that not only student borrowers but also recipients of some other pandemic-era relief programs — such as restaurant revitalization grants — will need to pay state taxes on the federal funds.

Marquart said the student loan forgiveness tax break would have cost the state $200,000, but that will now increase.

"This delay ... creates a lot of uncertainty, more complexity, higher costs and more stress for students," he said.

Minnesota is one of at least five states, including Wisconsin, whose laws would tax student debt relief, according to the national nonprofit Tax Foundation. There is a narrow window for states to change the laws, said the foundation's Jared Walczak. If states don't act well before the tax filing deadline of April 15, he said, they could face a raft of amended tax returns and refunds.

"If states want to make a change, they want to make it early in the next legislative session," Walczak said, adding that he is hearing rumblings that Minnesota, Wisconsin and Arkansas could act. "Whether that will come together is anyone's guess."

Walz's GOP opponent in the gubernatorial race, former state Sen. Scott Jensen, stressed the need to conform with federal tax policy more broadly during a Star Tribune interview at the State Fair. Like many other Republicans, Jensen criticized and questioned the fairness of Biden's plan.

"Should people have their student loans forgiven when it's being paid for by the farmers, the plumbers, the electricians, the trades, the people who paid off their student loans?" Jensen said, calling it "raw pandering, trying to get votes in the November election."

Marquart said the issue of debt forgiveness has become so political that he doesn't like the odds for passage of a tax bill that addresses it.

"To think that anything might happen by next May, chances are probably against that," he said. He also pointed out that massive tax bills are rare and difficult to pass.