Wisconsin poised to tax student loan debt relief but how may be more complicated than it sounds

Republican legislative leaders want some of the state's record-high $6.6 billion budget surplus to go toward cutting taxes next year. But they've been silent about whether their broad support for tax cuts should include a tax exemption for student loan forgiveness.

On the federal level, student debt relief is tax exempt until 2026 because of a provision in the American Rescue Plan Act. But unlike more than 40 other states, Wisconsin's state tax code differs from the federal government’s when it comes to student loan forgiveness. This means borrowers eligible for the Biden administration’s student debt relief may be on the hook for hundreds of dollars in additional state income taxes unless state law changes.

If the Republican-controlled Legislature declines to take action, there's a major hurdle to collect the tax: The state Department of Revenue has no way of knowing who has had their student debt forgiven and owes money to the state.

Typically, student loan servicers send 1099-Cs — the tax form needed for filing debt cancellation — to taxpayers who receive more than a couple hundred dollars in student debt forgiveness. But earlier this year, the Internal Revenue Service told servicers they are “not required to, and should not" provide the form to borrowers or to state tax departments.

This means many Wisconsinites likely won't receive the right form to file student debt relief on their taxes. It also means keeping the tax in effect essentially leaves the state Department of Revenue relying on an honor system.

"We would not know who has had debt forgiven," Department of Revenue spokesperson Patty Mayers confirmed to the Journal Sentinel when asked how the agency would enforce collection of the tax. "The tax system is built on a foundation of taxpayer compliance. We do our best to make information ... available to taxpayers, so they can be informed, and, in turn, compliant with tax laws."

Despite the loophole, tax professionals advise Wisconsinites to report loan forgiveness as income even if they don’t receive a 1099-C.

"As far as a mechanism states have, as far as I know, they don’t have an easy way to collect in the absence of a 1099-C," said Genaro Cardaropoli, a certified public accountant and president of Hjortness and Associates, a tax and accounting firm based in Menasha. "But just because it's not reported doesn't mean it's not taxable."

Cardaropoli recommended borrowers seek the help of a tax professional because the debt may be excluded as income under the "insolvency" exclusion, which would reduce a taxpayer's tax burden.

Most Wisconsin borrowers can expect to be taxed about $530 by the state, according to The Tax Foundation, a Washington, D.C.-based think tank.

Altogether, the state tax could generate $380 million based on a new estimate from the nonpartisan Legislative Fiscal Bureau.

Democratic Gov. Tony Evers doesn't think Wisconsinites who have their student loans forgiven should be penalized with more income taxes, and he asked for an exemption in the next state budget.

Assembly Speaker Robin Vos, R-Rochester, Senate Majority Leader Devin LeMahieu, R-Oostburg, and the co-chairs of the budget-writing committee — Sen. Howard Marklein, R-Spring Green, and Rep. Mark Born, R-Beaver Dam — either declined to comment or did not respond to multiple requests for comment.

Is student loan forgiveness even legal?

Looming over the debate on whether to tax student loan forgiveness are questions about the legality of the Biden administration's program itself. The plan calls for canceling up to $20,000 in debt for millions of federal borrowers who earn less than $125,000 annually, including 685,00 borrowers in Wisconsin.

There have been a number of lawsuits, including one in Wisconsin, targeting Biden's program. Most have failed, but the U.S. Supreme Court last week agreed to hear arguments in February in a case led by six Republican-led states who say the president lacks the authority to wipe out billions of dollars in student debt.

In light of the legal challenges, the U.S. Education Department has stopped accepting student loan forgiveness applications. Nearly 26 million borrowers had already applied, and the White House said about 16 million applications have already been approved, but no debt has been canceled yet.

The timing of the lawsuit taken up by the U.S. Supreme Court means borrowers likely won't have to worry about tax implications until the spring 2024 filing season, Cardaropoli said.

Contact Kelly Meyerhofer at kmeyerhofer@gannett.com. Follow her on Twitter at @KellyMeyerhofer.