Paul L. Caron

Tuesday, May 21, 2024

Brooks: The (Non)Taxation Of Student Debt Cancellation: Statutory Misinterpretation And Normative Conflict

John R. Brooks (Fordham; Google Scholar), The (Non)Taxation of Student Debt Cancellation: Statutory Misinterpretation and Normative Conflict, 77 Nat’l Tax J. __ (2024):

National tax journalStudent debt cancellation is an increasingly important form of subsidy for higher education and reflects a shift toward financing higher education with income-contingent loans. But the legal formalities of debt cancellation expose borrowers to the risk of taxation, especially after 2025. This paper shows that the IRS and Treasury's position that student debt cancellation is sometimes taxable is based on a misreading of the tax code and its history. I further argue that this misreading arises in part because of the conflicting norms of tax policy and non-tax social policy, a conflict that arises in other transfer contexts as well.

Student debt cancellation has gradually, and then suddenly, become one of the largest sources of financial aid for higher education. And that is so just considering current repayment and discharge plans, not the further court-challenged proposals for one-time, lump-sum forgiveness. Student debt cancellation is now central to the United States’ overall scheme of higher education finance and social policy. Furthermore, debt cancellation is increasingly becoming a tool for government redistributive social policy in other policy areas as well.

But the debt cancellation tool reveals some under-appreciated conflicts between tax policy and other social policies. In particular, the norms of taxation generally treat cancelled debt as gross income for tax purposes, a position that could undermine the efficacy of using debt cancellation as a policy tool. Those tax norms are strong enough that they have even overridden Congress’s statutory commands otherwise, as this paper has shown happened with student debt. Congress long intended for student debt cancellation to be treated as excluded scholarships, but that intent was just buried enough in the history that the IRS and Treasury never sought it out, believing perhaps that section 108(f) spoke clearly enough on its own.

There is not an easy solution to this problem. Even the tools and doctrines that were developed for other social policy areas, such as the general welfare exclusion, are imperfect and inconsistent. It may be that the most effective solution is just for Congress to state clearly its intent for debt cancellation and other transfers to be taxable or not, rather than to leave it to the IRS and Treasury. Indeed, the central story here is one where normative conflict leads to errors in statutory interpretation. We are unlikely to change tax law norms—nor should we necessarily want to—which means the burden may be on Congress to make sure that its legislation cannot be misread.

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