Expanding Income-Based Repayment To Solve The Student Loan Debt Crisis Could Create An Even Bigger Problem
#DeferStudentLoanDebt? Doesn’t really have the same ring to it, does it? Even still, as the Biden administration inches closer to a decision on whether it will cancel trillions of dollars of student loan debt, many questions remain about how the plan will affect individuals with significant obligations.
While many of the prominent Democrats in Washington have been advocating for President Biden to forgive as much as $50,000 of student loan debt for each borrower, the President is mulling a number of options. One that is under consideration is a plan that would allow more Americans to qualify for income-based repayment.
Allowing more borrowers to get on this repayment schedule would undoubtedly help in the short term. Income-based repayment uses borrowers’ tax returns to calculate a minimum payment that they can reasonably afford given their financial status. What’s more, provided payments were made on time, the plans allow for the debts forgiven after either a 20-or-25-year period. However, that remaining balance has the potential to saddle borrowers with an entirely new tax burden, one that could hasten the start of an even bigger crisis.
Currently, thanks to a provision included in the $1.9 trillion federal coronavirus stimulus package that became law in March 2021, student loan forgiveness is tax-free. However, in the past, any student loan debt canceled by the government was considered taxable and levied at the borrower’s normal income tax rate.
Consider the two numbers that have been floated for cancellation: $50,000 per borrower and $10,000 per borrower. According to a rough estimate by higher education expert Mark Kantrowitz, a $50,000 cancellation would have triggered an extra $10,000 in taxes for the average borrower. If $10,000 per borrower was canceled, the average person would have to write the IRS a check for $2,000. That’s a huge savings on whatever amount the President decides to forgive. But therein lies the rub: How long can borrowers expect that forgiveness will remain tax-free?
A $10,000 forgiveness would still leave roughly two-thirds of borrowers with student loan debt. In an attempt to extend some goodwill to those with a remaining balance, the President could make allowing borrowers to all qualify for income-based repayment a secondary pillar of his plan. But would that open the door to a second crisis?
As the law is currently written, student loan forgiveness is “permanently” tax-free. As anyone that follows tax law can tell you, permanent doesn’t always mean permanent. Just take 2017’s Tax Cuts and Jobs Act, which was the most significant reform to the tax code in decades. One of the primary components of the law was that it established a limit to the amount of state and local taxes taxpayers can deduct. Tax filers in states like New York, New Jersey, and Connecticut that had been deducting property taxes that exceeded $10,000 for generations, learned the hard way how quickly permanence can become the past.
So it seems logical that, at some point, there will be a push – whether by rival lawmakers or loan servicers – to once again make debt forgiveness taxable. After all, if there is no incentive to pay anything more than the minimum on these income-based repayment plans – knowing that even 20-consecutive years of on-time payments could see a borrower’s balance increase, depending on the interest rate – why would anyone pay more?
That’s why those with more than $10,000 of student loan debt have to be both vigilant and incredibly discerning about what comes next. If borrowers – especially ones with higher interest rates – don’t allow for the possibility that forgiveness could once again become tax-free, they could find themselves caught off guard if/when the goal posts get moved. And if that happens, it won’t be loan services calling; it will be the IRS, and that is a collector that will not look the other way on a past-due balance.