The new tax reform changes went public earlier this morning. Here is the link that the House Ways & Means released. The tax reform bill is entitled, “Tax Cuts and Jobs Act.”
In my last post about a new bill addressing student loan debt forgiveness, I mentioned that student loan debt that is forgiven may be viewed as taxable income. I wanted to further clarify my earlier statements. As with most things, there are exceptions.
Generally speaking, debt that is forgiven is typically viewed as income by the IRS and this means that it will be taxed. Again, this is a very general rule. But, there are many exceptions to this rule. For example, from 2007 to 2014, this general rule did not apply to short sales with mortgage debt that is cancelled or forgiven because of the Mortgage Forgiveness Debt Relief Act.
Similarly, with student loans, the specific area in the code that refers to gross income exclusions for student loans is 26 U.S.C. Sec. 108(f). In addition, the IRS has a publication available here that states if you work for a 501(c)(3) tax-exempt organization for a certain period of time under certain conditions, then your student loan forgiven debt will be discharged and not viewed as gross income. Within the publication and within the student loan debt forgiveness programs, there are additional parameters that must be met by the borrower (too long to go into for this post, but I can save it for another post if readers are interested in learning more). But, in short, there is an exception to student loan debt forgiveness taxability. Additional information about student loan debt forgiveness is available in this other IRS publication on page 4 available here.
One of the biggest technicalities to student loan debt forgiveness is the taxability of the forgiven debt. This means that a person could work in public interest for 10 years or have a low salary for 25 years and get all their consolidated student loan debt forgiven (and have affordable payments through out the repayment period), but the forgiven debt will be treated as taxable income.
Depending on how big that forgiven debt is, the tax liability may be completely unaffordable to the student loan borrower. Thus, this is one of the big potential flaws or big red flags to student loan debt forgiveness.
Recently, Senator Jeff Merkley (D-Ohio) introduced a bill called the Income-Based Repayment Debt Forgiveness Act. Most importantly, the Act “would ensure that students are not taxed on debt that is forgiven at the end of this process” under Merkley’s new repayment system.
Merkley goes further to explain that under the Income-Based Repayment Debt Forgiveness Act and his proposed Access to Fair Financial Options for Repaying Debt (AFFORD) Act, there would be a two type repayment system. The two type system has some similarities to the current student loan loan repayment system and the same premise as an income based repayment plan, but it would get rid of the public service loan forgiveness program and removes some of the other repayment plans.
Merkley describes the AFFORD Act in a press release on August 5, 2015 excerpted below.
“One would be the traditional fixed repayment plan, in which borrowers pay the same amount each month over a set period of time to pay off the full balance and interest on the loan.
The other would be an income-based repayment plan modeled on the current Pay As You Earn (PAYE) model. Under the PAYE model, the borrower would pay 10% of his or her discretionary income and have any remaining debt forgiven after 20 years.”
The full text of the bill is available here.