California Excludes Forgiven Student Loans from State Income Tax

California will not tax student fees and loans forgiven as part of COVID-19 relief. AB 111, a budget trailer bill, passed unanimously in the state Assembly and Senate, and Governor Gavin Newsom signed it into law on May 15, 2023.

The bill excludes discharged unpaid community college fees from an individual’s taxable income for state tax purposes for tax years beginning during 2022–2026. It also excludes higher education emergency grants for tax years beginning during 2020–2027. Lastly, the bill conforms to federal law on student loans by excluding loans discharged during 2021–2025 from taxable income for tax years beginning during 2021–2025.

Generally, debt that is canceled, forgiven, or discharged for less than the amount owed is taxed as income. The American Rescue Plan of 2021, however, exempted forgiven student debt from federal taxation through 2025. AB 111 clarifies that California’s tax treatment for loan forgiveness will conform to federal law.

The bill is not expected to impact state revenue, as California did not project or anticipate that individuals receiving fee or student loan forgiveness would be taxed by the state. Legislative staff analysis projected that the taxation of loan forgiveness could have raised up to $850 million in 2023–2024 and $450 million in 2024–2025. The taxation of forgiven community college fees was projected to have generated tens of millions of dollars in revenue.

The bill comes amid uncertainty surrounding President Biden’s student loan debt relief plan, which includes up to $20,000 in student loan forgiveness. The plan is on hold due to legal challenges. The U.S. Supreme Court is expected to issue a decision by the end of June.