When we did our taxes this past year, it looked like we were actually going to get a marginal refund. We weren’t really expecting it because half of the year one of my wife’s paychecks (she is paid by two institutions) wasn’t withholding any taxes. That’s usually a recipe to have to cut Uncle Sam a paycheck. So it was a pleasant surprise to find out that it almost evened out exactly. We’d owe the state a bit of money, but the feds would owe us.

Then we got that one last form: Debt forgiveness. We live in an underserved area, and so there is some loan forgiveness involved. The thing about loan forgiveness, though, is that it’s taxed as income.

Senate Democrats, however, are on it:

New loan forgiveness programs were supposed to make it easier for those students who were unable to pay, but a provision in the Tax Code can make a bad situation worse: the amount of the loan forgiveness is considered income for federal tax purposes. In other words, if your student loan debt of, say, $25,000, is written off, that same amount, $25,000, is treated as though you received cash in hand – and it’s taxed.

That tax treatment doesn’t just include student loans in default but also those that are discharged because of death or disability, or those with balances written off under federal income-based repayment (IBR) and income-contingent repayment (ICR) loan forgiveness programs.

Senators Bob Menendez (D-NJ) and Elizabeth Warren (D-MA) are hoping to change that. The pair, together with Ron Wyden (D-OR), Debbie Stabenow (D-MI) and Cory Booker (D-NJ) have introduced the Student Loan Tax Relief Act. The Act would exempt student loans discharged for any reason from being taxed as income.

I have mixed feelings about this. I don’t like it, and I also don’t like it.

What I mean is my first response is “Oh, yeah, now you do this! After we’ve already paid!” Except that we’re going to have to pay again next year, which should be the last year. But It’d almost be worth it to pay it next year just so that I can wave my cane at those deadbeats who aren’t paying their fair share.

Well, not really. The second “I don’t like it,” though is that I think we were right to have to pay it, and others whose debts are forgiven (or defaulted on) should have to pay it, too. Though obviously we are going to accept it as it comes, I think compensation through this mechanism is generally not a good idea. It’s often scheduled in such a way as to give recipients false hope. It’s the compensation equivalent to mail-in rebates. The fact that a lot of people who think they’re going to be getting it don’t get it is built in to the whole scheme.

It’s also economically inefficient. We would have paid off our debt by now if it weren’t for this program and ones like it. We are structuring how we tackle our debts in part in response to this program, and that strikes me as a net loss. Better we have a program to simply give physicians in underserved areas a paycheck boost.

Granted, we are not who the senators have in mind anyway. They are mostly interested in helping out those who default on their loans. I guess I have some sympathy for them and this is the government itself taking a haircut and that’s better than demanding that creditors do. Offering it to people like us is mostly a way of making it seem like it’s not about the defaulters, and maybe getting some upper class support. Which, to be fair, I don’t mind benefiting from.

Category: Bank

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13 Responses to Taxed Relief No More

  1. It strikes me as strange that a defaulted loan should be counted as income and taxed accordingly. If someone defaults, they’re still on the hook and wages and checks can (and from what I hear, will) be garnished and credit reports will be negative. That, and not income tax, should be the cost of defaulting. But I’m not a tax expert.

    As for the broader point, I’m not sure what the solution should be. When I had a much lower income and feared for my ability to pay my loans, I looked into income contingent payments and it was very clearly written that any amount forgiven after the 25 years or so would be taxed. I knew what I would have gotten myself into if I had chosen that route. It would have been an incentive to make extra payments when I could to lower the tax burden later. I realize I tend to read things before I sign them and not everybody does.

    Maybe there could be a middle ground solution. Maybe only 50% of the forgiven balance should be taxable, or perhaps ratchet that proportion even lower if the person had made extra payments onto the principal.

    • Brandon Berg says:

      Going into default isn’t taxable. It’s only taxable when the debt is discharged, at which point your paychecks can’t be garnished, because you no longer have the debt. You still take the hit on your credit rating, because you’ve demonstrated that you’re not a good credit risk, but the discharge of the debt really is income. You had -$50,000, and now you have $0. That’s $50,000 in income.

      Note, however, that income taxes in the US are ridiculously progressive. If you’re single, you can make up to around $45,000 in a year without getting out of the 15% tax bracket, and the limits are significantly higher if you’re married and/or have dependents. So basically this just means that instead of having your debt completely canceled, it’s really only 80-90% canceled.

      Not taxing debt forgiveness opens the door to a lot of tax avoidance schemes. For example, to avoid the death tax, you could lend money to your heirs and have the debt canceled upon your death. Or, if they trust you enough, you could even pay your employees in loans and then forgive that debt.

  2. Brandon Berg says:

    Better we have a program to simply give physicians in underserved areas a paycheck boost.

    This seems like a better way of dealing with it to me, too. Why should the rural doctor subsidy be limited to people who have medical school debt? The only reason I can think of that it would make sense is that maybe they’re hoping to get people to move there to get their debts forgiven, get used to it, and stay. That way the area gets the doctor for his or her whole career while only having to pay the bonus for part of it.

    • Jaybird says:

      And even the ones who say “I’m out of this backwater hick town!” 2 minutes after the last cent is forgiven, are creating a vacancy for the latest/greatest greenhorn fresh out of residency.

    • SFG says:

      I suspect you simply can’t pay the doctors enough to move there–they’d rather take bad salaries in Manhattan, NY rather than a million dollars in Manhattan, KS, because the ‘bad’ salaries are enough to live on still. But they want to get rid of the debt, so they’ll move there to get rid of the debt.

      Forgive my big-city bias, but if it’s that hard to get people to move to rural areas, maybe these areas just don’t need the population anymore? I mean, obviously someone has to extract oil and grow crops, but maybe we just don’t need that many people doing it anymore? Kevin Williamson got a lot of c*** for claiming rural communities needed to die, and he deserved it for insulting people down on their luck, but I kind of wonder if we’d be better off just letting a lot of places turn into ghost towns and subsidizing the movement of the people to new places. (Big government, I know.)

      • trumwill says:

        The signing bonuses and debt forgiveness generally don’t make up for the salary differentials anyway. Places with shortages pay less. Sometimes significantly so, even when you factor everything else in.

        Also, places with shortages tend to be self-fulfilling. Short of staff means you need everyone there to work longer, which increases burnout, which creates more shortages, which…

        I think the solution, to the extent there is one, is to fiddle around with residency requirements of foreign docs that are already licensed to practice in comparablely competent foreign countries like France and Britain (even South America). Two years on the job in BFE counts as a year of residency. That sort of thing.

        Not gonna happen.

    • trumwill says:

      A lot of hospitals do that “lure them and hope they stay” with generous signing bonuses, officially interest-free loans retired over the term of the contract.

      You pay taxes on the forgiveness, but they factor that into your withholdings pretty automatically.

      Its probably just psychological. People just don’t think it through. And it’s easier to jilt people on. Signing bonuses can more easily be expected upfront.

  3. Oscar Gordon says:

    I don’t think the whole should be forgiven, but the government could instruct the IRS to create a generous tax payment plan for beneficiaries if the tax burden is too much.

    • Jaybird says:

      Stay in the rural area and get tax forgiveness for a few years.

      Figure out how to game this the right way and we can completely distort the market.

    • There is an irony in that position. In cases where this program would apply, a person would have their debt forgiven only to be launched onto a new debt payment plan but now with the IRS.

      That doesn’t mean it’s a bad plan. If the amount forgiven is treated as income, then the tax won’t be equal to the income, but some percentage thereof. So a lot less would be owed, and combined with the generous repayment terms from your plan, it could be a much better outcome.

      Perhaps as an addendum, the forgiven amount might not be taxed as the next bracket of income, but taxed at a fixed (and lower) rate?

      • Oscar Gordon says:

        Thing is, there is no logical justification for not taxing it as some form of income, because it is essentially that.

        I could see taxing it at the current year tax bracket, which would discourage people with high incomes from trying to game it, while letting low income people avoid a painful hit (e.g. if I’m underemployed and my tax rate is 10%, then the loan amount is taxed at 10%, and the income does not count against me the next year). In that manner, some people, who are really hard up, can avoid having it taxed at all.

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