Wall Street Journal, Student-Debt Forgiveness Is a Wonderful Boon, Until the IRS Comes Calling:
Students seeking relief on their college and graduate-school debt could be sitting on a hidden tax bomb: Billions of dollars in one-time bills from the Internal Revenue Service for any debt they get forgiven.
The tax bills are a feature of the “income-driven repayment plans” that have been offered by the Education Department since 2007. One version of these plans allows borrowers to set their monthly student-loan payments at 10% of their discretionary income. The balances often grow over time because the payments aren’t big enough to cover accruing interest.
Private-sector workers pay for 20 or 25 years. At the end of that period, any remaining balance would be forgiven. Under federal tax rules, that disappearing debt is considered part of a borrower’s income for that given year, and taxed as such.
Those delayed tax bills are piling up. There are now 7 million borrowers owing $389 billion in income-driven repayment, according to the Education Department. The first borrowers likely won’t have debt expunged until 2027. As enrollment surges, education analysts and student advocates are warning of a potential crisis facing borrowers and the government down the road: huge one-time tax bills that individuals aren’t prepared to pay off.
With the inflating tax bills, the plans for some borrowers resemble “balloon payment” plans offered by some mortgage lenders, under which borrowers make low monthly payments for a period and then are required to make a big, one-time payment to pay off the sum. Some policy makers have criticized balloon payments as a form of risky lending.
“I’m very doubtful that everybody is going to be able to make these tax payments,” said Constantine Yannelis, an assistant professor of finance at New York University who worked in the Obama Treasury Department. “And I’m also doubtful that policy makers and society as a whole are going to be OK with jailing people for tax evasion because their student-loan balances are being forgiven.”