Paul L. Caron

Monday, June 8, 2015

Crespi: The 'Tax Bomb' Facing Lawyers Who Enroll In Income-Based Student Loan Repayment Plans

IBRGregory Scott Crespi (SMU), Should We Defuse the "Tax Bomb" Facing Lawyers Who are Enrolled in Income-Based Student Loan Repayment Plans?:

Starting in the early-2030's each year thousands of mid-career lawyers who have previously incurred large student loan debts, and who unfortunately have been able to earn only relatively modest annual incomes in the 20 or 25 years following their law school graduation, will be subject to large cancellation of indebtedness-based federal and sometimes also state income tax obligations. These tax bills will often be in the neighborhood of $50,000 to $100,000 and in some instances even larger. Many of these lawyers will likely have failed to adequately provide for this large tax obligation and will find that it will impair or even devastate their retirement plans.

The phrase “tax bomb” is an apt one to describe this large tax obligation that will be imposed on income that is attributed to but not actually received by a relatively small group of taxpayers. It will result because a large portion of the student loan debts that have been incurred by many law school graduates will eventually be forgiven under one or another variant of the increasingly popular federal Income-Based Repayment Plan, and those forgiven debts will then be treated under the Internal Revenue Code as taxable income.

This article explains how this tax bomb was created and how the various statutes and regulations that define its scope and size have evolved over time, and how much but not all of its impact will be substantially reduced by the Department of Education’s proposed new Revised Pay as You Earn rules that will be in force as of December of 2015.

It then offers detailed illustrative calculations regarding its magnitude, both for individuals and in the aggregate. My estimate is that the aggregate impact of the tax bomb on lawyers alone will be roughly several hundred million dollars or more per year, starting in about 2032, and the impact will larger, perhaps significantly so, if the comparable tax obligations that will be imposed on medical school graduates and other graduate and professional school borrowers, and on persons who have borrowed only for undergraduate studies, are also considered.

Finally, the article discusses whether measures should be taken to mitigate or even eliminate this tax bomb before these obligations begin coming due. I have concluded that no such measures are called for except for a minor amendment to the Internal Revenue Code allowing persons to pay their tax liabilities on forgiven student loan debt over several years. However, I also discuss several other alternative measures that might be taken to reduce the tax bomb’s consequences.

Update:  Wall Street Journal, Young Lawyers Could Face ‘Tax Bomb,’ Says Professor

Legal Education, Scholarship, Tax | Permalink


Jack, most middle class Americans expect to receive a modest inheritance from their parents or grandparents. Something in the amount of $100-300k. The tax bomb will essentially wipe that out if it is received prior to the 30 year expiration. Most people considering JD's don't envision being insolvent at the age of 56 anyway. So the tax bomb still causes huge problems for most people on IBR.

Posted by: JM | Jun 9, 2015 1:13:06 PM

So tired of all the "tax bomb" talk, for three reasons: (1) There is an insolvency exception. (2) There is an insolvency exception. (3) There is an insolvency exception.

Posted by: Jack Bogdanski | Jun 9, 2015 8:14:05 AM

It is far better to owe tax money than student debt. Tax debts can in some circumstances be discharged.

Posted by: Walter Sobchak | Jun 8, 2015 5:09:22 PM


"Negotiators on a federal rule-making panel have agreed on a plan to expand and remake Pay as You Earn, the most generous of the student-loan income-based repayment plans. The revised program — dubbed REPAYE, short for Revised PAYE — would be at once more inclusive and more targeted than the current plan... Under the new plan, higher-income borrowers would pay a larger share of their income each month. Students who borrowed for graduate school would pay for an additional five years before their loans were forgiven, and married borrowers would, with some exceptions, be required to make payments based on their joint income and debt."

And as to my earlier point,

"Republicans in the U.S. House of Representatives and Senate have reached agreement on a spending blueprint for the 2016 fiscal year that could lead to deep cuts in education spending and a reduction in benefits for student-loan borrowers.... The plan also assumes that appropriators will abolish the in-school interest subsidy on Stafford student loans, reverse a recent expansion of income-based repayment, and end public-sector loan forgiveness."

The times, they be a-changing.

Posted by: Unemployed Northeastern | Jun 8, 2015 2:59:08 PM

I would like an estimate as to the percentage of the voting population that will be carrying significant student loan debt as of 2032, assuming federal student lending remains as it is now, and tuition inflation continues.

This debt has already been nationalized. Direct federal student lending is US bond financed. What is the maturity on those bonds?

When we pay our federal student loans, is the federal government using those payments to pay down that portion of our national debt that is US bond financed, or do they spend it, today.

By my estimate Mr. Crespi will be somewhere on the order of 83 years old in 2032. Many current members of Congress will be dead in 2032.

There are few things more arrogant than having an 80 year old who borrowed money in your name with the bill due in the future many decades (if at all), who neither suffers the present consequences nor the future ones, dictate to Generation Y how they should deal with the mess the 80-year-olds created for them.

Posted by: Estimates | Jun 8, 2015 2:25:55 PM

Unemployed Northeastern-- note that what counts is your individual income, not your family income. Your family and make millions and qualify if you file an individual tax return. This would apply to a wife, but also, I suppose to the scion of a rich family whose trust fund is careful to pay out a small enough amount to him for whatever number of years is required.

Posted by: Eric Rasmusen | Jun 8, 2015 12:57:20 PM


Whether PSLF survives long enough for anyone's loans to be forgiven by it is a good test case of whether anyone can expect to have their loans forgiven under IBR or PAYE. PSLF is most definitely on the chopping block when Congress reauthorizes the Higher Education Act; there has been plenty of coverage on this over on the higher education websites (Chronicle, Inside).

Posted by: Unemployed Northeastern | Jun 8, 2015 12:55:00 PM

"if loans are forgiven because of inability to pay, there should be no tax consequences"

Generally, if you are insolvent when the loan is forgiven, you are not taxed on the forgiven portion to the extent of your insolvency.

Posted by: Rob | Jun 8, 2015 9:27:17 AM

PSLF is not taxable, so that will not be a good test case.

Posted by: Wisco | Jun 8, 2015 9:22:02 AM

It seems to me that if loans are forgiven because of inability to pay, there should be no tax consequences

Huh? They hired the money and got the thing they spent the money on. Why should they not pay taxes on a large amount of money they got? Are they going to give back the law degree? If not, then how did they not get a large amount of money?

Posted by: Gabriel Hanna | Jun 8, 2015 8:30:07 AM

Short version: You need to know tax law before you decide to study tax law.

Posted by: AMT buff | Jun 8, 2015 6:36:54 AM

Isn't this the same problem that has occurred in the RE market with foreclosures and short sales? It seems to me that if loans are forgiven because of inability to pay, there should be no tax consequences,

Posted by: Rick Caird | Jun 8, 2015 6:14:21 AM

"The conclusion is that the forgiven debt should be taxed in the usual way, which makes sense given the enormous gift these people, many of them rich, will be receiving anyway. "

Uh, rich people don't qualify for INCOME-BASED REPAYMENT, Eric. If your income is too high, you cannot enroll. If you come from great wealth, you weren't borrowing for law school anyways. And nice antediluvian commentary re: attending law school as a MRS program. Pity Mad Men has ended; you'd make a great extra. Also, Congress seems pretty determined to have spousal income factor into IBR/PAYE payments, and Obama and the DOE seem amenable to it as well. In fact, there seems to be much more traction in favor of using household income for IBR/PAYE payments than there is to get rid of the tax bomb.

And not to belabor the obvious, but this is all contingent on, inter alia, IBR surviving another 15-20 years. PSLF will make a good test case. The first forgivable cohort for PSLF forgiveness will mature in 2017, and there is an increasing call among Republicans to repeal it before then, including by several politicians who voted in favor of it back in 2007. If PSLF does not survive, it is a probable sign that IBR ultimately won't go the distance, either.

"Or, if your talents are such that with or without the law degree your expected income is only 150% above the poverty line"

Yes, it's a real shame we couldn't all be Baby Boomers and attend college when 1) a non-Ivy degree actually had merit in the job market, 2) it was cheap as dirt, 3) productivity gains still led to wage gains, 4) white-collar work wasn't being outsourced, etc, etc.

The Real Unemployed Northeastern

Posted by: Unemployed Northeastern | Jun 7, 2015 9:59:42 PM

Good work. This paper does the work of estimating how many lawyers will be forgiven and how much each (2 numbers that ought to be in the abstract along with the total tax cost). The conclusion is that the forgiven debt should be taxed in the usual way, which makes sense given the enormous gift these people, many of them rich, will be receiving anyway.

I see now why so many people go to law school with such poor job prospects. It is, for example, a great place to get your M.R.S. Suppose you borrow $200,000, go to law school, marry, and become a housewife or do charity work on low or no pay. At individual income less than 150% of the poverty level, you pay no interest on your loan, and in 20 or 25 years it is forgiven. At that point you have to pay income tax of, say, $70,000, but it's in 2035 dollars, not 2015 dollars. Or, if your talents are such that with or without the law degree your expected income is only 150% above the poverty line, you can at least pay for 3 years of living expenses this way, though you'll have to declare bankruptcy when the tax bill comes due.

Posted by: Eric Rasmusen | Jun 7, 2015 6:02:04 PM