Expanding income-tested repayment to solve the student loan debt crisis could create an even bigger problem


#DeferTheStudentLoan? It doesn’t really have the same resonance, does it? Even still, while the Biden administration inches closer to a decision As to whether it will write off trillions of dollars in student loan debt, many questions remain about how the plan will affect people with large obligations.

While many leading Democrats in Washington have advocated for President Biden to forgive up to $50,000 in student loan debt for each borrower, the president is considering a number of options. The one who is under consideration is a plan this would allow more Americans to qualify for an income-based refund.

Allowing more borrowers to adhere to this repayment schedule would undoubtedly help in the short term. Income-based repayment uses borrowers’ tax returns to calculate a minimum payment they can reasonably afford given their financial situation. In addition, provided that payments are made on time, the plans provide for the cancellation of debts after a period of 20 or 25 years. However, this remaining balance has the potential to impose an entirely new tax burden on borrowers, which could hasten the onset of an even more serious 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-exempt. However, in the past, any student loan debt canceled by the government was considered taxable and levied at the borrower’s normal tax rate.

Consider the two figures that were issued 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 resulted in an additional $10,000 in taxes for the average borrower. If $10,000 per borrower were forgiven, the average person would have to write a check to the IRS for $2,000. That’s a huge saving on any amount the president decides to pardon. But therein lies the catch: how long can borrowers expect the discount to remain tax-free?

A $10,000 forgiveness would still leave about two-thirds of borrowers with student loan debt. In a bid to extend some goodwill to those with a remaining balance, the president could make all borrowers eligible for income-based repayment a secondary pillar of his plan. But would that open the door to a second crisis?

As the law currently stands, student loan forgiveness is “permanently” tax-exempt. As any tax-abiding person can tell you, permanence is not always mean permanent. Just take the Tax Cuts and Jobs Act of 2017, which was the most significant tax code reform in decades. One of the main elements of the law was that it set a limit on the amount of state and local taxes taxpayers can deduct. Filers in states like New York, New Jersey and Connecticut, which had been deducting property taxes over $10,000 for generations, have learned the hard way how quickly permanence can become the past.

So it seems logical that at some point there will be pressure – whether from rival lawmakers or loan managers – to make debt forgiveness taxable again. After all, if there’s no incentive to pay 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?

This is why those who have more than $10,000 in student debt must be both vigilant and extremely demanding about what happens next. If borrowers – especially those with higher interest rates – do not consider the possibility that the discount may become tax-free again, they could find themselves caught off guard if/when the goal posts are moved. . And if that happens, it won’t be the lending services calling you; it’ll be the IRS, and it’s a collector who won’t look away from an overdue balance.


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