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Wisconsin Republicans want to tax student debt relief. It might be nearly impossible to enforce.
There’s good news, and murky news, for Wisconsin borrowers. Guest column from Phil Rocco and Robert Dietterick.
The Recombobulation Area is a six-time Milwaukee Press Club award-winning weekly opinion column and online publication written and published by veteran Milwaukee journalist Dan Shafer. Learn more about it here.
Last week, following a decade of grassroots organizing, President Biden announced a plan to wipe out $10,000 in student loans for 43 million Americans, and up to $20,000 for those who received Pell Grants to attend college. For borrowers across the country, the announcement has led to a swirl of questions. Am I eligible? When can I claim the relief? Will my canceled debt be taxed?
Where taxes are concerned, there’s good news, and murky news, for Wisconsin borrowers.
First, the good news. Under the American Rescue Plan Act (ARPA), student borrowers won’t have to pay federal income taxes on any debts they have discharged.
Now for the murky part: When it comes to Wisconsin’s state income tax, borrowers benefitting from debt relief might not be so lucky. The state is now one of only five across the country that may continue to treat debt relief as taxable income.
At the heart of the issue is how Wisconsin conforms its state tax laws to the federal Internal Revenue Code (IRC). To reduce administrative burdens on taxpayers, most states conform their tax laws with the IRC in some way. Yet while 29 states have “rolling” conformity with federal tax laws––meaning that the state automatically updates its tax laws when the federal tax code changes––Wisconsin is one of 18 states that employs so-called “static” conformity. This means that when federal policies change, the state legislature typically must pass new laws to bring the state tax code into line with the IRC.
Wisconsin often has no problem making changes like this one. But Republican members of the state legislature appear unwilling to extend this logic to student debt relief. Even so, recent changes in federal law might make it almost impossible to enforce a tax on canceled student debt.
Wisconsin often conforms with major federal tax changes, but this time could be different.
While it still requires legislative action, the Wisconsin state legislature is not exactly averse to conformity with the IRC. A 2018 conformity bill, which passed in the wake of the Tax Cuts and Jobs Act, resulted in significant administrative simplification and savings for taxpayers in the state. More recently, when Congress passed the CARES Act during the early days of the COVID-19 pandemic, it excluded loan forgiveness under the Paycheck Protection Program (PPP) from treatment as taxable income. Less than a month later, the Wisconsin State Legislature passed––and Gov. Evers signed––legislation incorporating those tax code changes into state law. A year later, following Congress’s extension of that policy, as well as the allowance for deductions for expenses paid with PPP loan funds, Wisconsin quickly conformed with these provisions.
There are a few reasons why states, even those with “static” conformity like Wisconsin, typically update their laws to reflect changes in the IRC. By mirroring federal definitions and rules, conformity limits the costs and administrative burden on the state’s Department of Revenue. Taxpayers also benefit. Harmonized rules make taxes easier to file with fewer opportunities for errors.
Yet Wisconsin is now one of five states that will have to make changes to its tax laws to conform with current federal policy on the tax treatment of student debt relief. Under Section 9675 of the American Rescue Plan Act, the IRC does not treat the forgiveness of student loans debt between 2021 and 2025 as taxable income.
The Department of Revenue, as it does routinely when federal changes to the IRC are made, has asked that the state pass legislation to conform with these provisions. Gov. Tony Evers has also directed the Department to deal with the discrepancy in the next state budget. Yet Republicans in the state legislature have indicated that they are unwilling to come back into session during their nine-month legislative break to do the routine updating of the state’s code to conform with the IRC. "This might be the first tax break I'd oppose," said Wisconsin State Representative Adam Neylon (R-Pewaukee) in an interview with the Milwaukee Journal Sentinel.
Taxes could affect up to 785,000 student-loan borrowers.
The burden of student debt in Wisconsin is well known. Like their peers across the country, the majority of Wisconsin college graduates complete their degrees in debt. The financial burden of repaying student loan debts also has knock-on effects across the economy. With imperiled credit scores, borrowers have weaker purchasing power. This means they are less likely to purchase a home, start a business, or save for retirement.
For middle-income taxpayers in Wisconsin, the effects of nonconformity with the IRC would be significant. According to the Federal Reserve Bank of New York, there are 785,000 student-loan borrowers in Wisconsin, with a total balance of nearly $25 billion. As of the end of 2021, the median borrower balance in Wisconsin was $17,037. Because of the American Rescue Plan Act, none of the relief these borrowers experience will count as income for the purposes of federal income tax. Yet should Wisconsin fail to conform state laws with the IRC, borrowers would owe income taxes on that relief. So, assuming a single borrower with an annual income of $50,000 has $10,000 in student debt discharged, she could owe—under current rates—at least $530 in additional state taxes, depending on her other credits and exemptions. Were the borrower to claim an additional $10,000 of relief––as Pell Grant recipients can––that amount would double.
There could be an administrative fix, if the IRS acts.
When it comes to tax relief for student borrowers, the ball currently seems to be in state Republicans’ court. Yet either the Internal Revenue Service (IRS) or the US Treasury could take actions that would make a new piece of legislation unnecessary.
Under current federal interpretations of the law, states would have to incorporate ARPA’s tax provisions to exclude student debt relief from treatment as income. The IRS or the U.S. Treasury could potentially issue new regulations revising their pre-ARPA interpretation of the existing law to exclude student debt cancellation from treatment as income.
John R. Brooks, a professor of tax law at Fordham University, suggests this interpretation of the law contradicts the way the IRS originally treated student loan cancellation under section 108(f) of the Internal Revenue Code: as a non-taxable scholarship. The Treasury and the IRS have numerous authorities they could use to revert to this earlier interpretation, Brooks has shown.
There’s been no indication yet that the IRS is gearing up to revise the pre-ARPA interpretation of section 108(f), and it seems unlikely at present. Should it happen, however, it would allow the Department of Revenue to issue new guidance excluding canceled debt from state income taxes. Under the Wisconsin Administrative Code, any Treasury regulation interpreting a provision of the law that has application to the determination of Wisconsin taxable income “shall be deemed a tax rule.”
In other words, if the IRS updates its interpretation of the laws to which Wisconsin already conforms, those interpretations become law here too.
Whatever happens, enforcing taxes on loan forgiveness might be practically impossible.
Yet even if Wisconsin ultimately decides to tax canceled debt, there is the question of how the state will enforce these taxes.
It’s worth remembering that state tax agencies “piggyback” on information that taxpayers report on their federal returns. Wisconsin’s income tax form asks filers to report Federal Adjusted Gross Income (AGI) from Form 1040. Yet under ARPA, filers who have their debt canceled won't include canceled debt in their AGI.
Thus even if Wisconsin doesn’t conform to the ARPA rules on canceled debt, it will have to rely on taxpayers reporting debt cancellation on their own. But ARPA rules will make that part tricky, too.
Following ARPA’s revisions to the tax code, in December of last year, the IRS directed lenders or servicers of most student loans not to issue information returns, the 1099-C forms that normally accompany debt forgiveness, or payee statements to borrowers. That rule will apply through 2025.
In past cases where the IRS did not require the issuance of 1099-C forms for student debt cancellation, Brooks reports finding no evidence of “any state attempting to assert taxation.”
In the absence of these forms, it might be practically impossible for the state to tax canceled debt––whether the legislature acts, or not.
Philip Rocco is an associate professor of Political Science at Marquette University
Robert Dietterick is a graduate student in Marquette University’s Political Science Department
Follow Dan Shafer on Twitter at @DanRShafer.