Gregory 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