I want to echo other posters and say this is the best and most honest internet resource about Student Loans I have found.
It is well known and touted that after paying and remaining current on Federal student loan debt, that after 20 or 25 years (depending on the program) the balance will be forgiven. Hooray.
I want to ask about what I call the “Pink Elephant” of student loan forgiveness…that being the conversion of forgiven debt into a 1099 which will be imputed to you as income and on which you will owe income tax. With IBR or ICR programs, many borrowers are not even covering the interest on their loans. Throw in a deferment or 2 for periods of unemployment, usurious interest rates, and add a high loan balance to the equation, and this can easily result in a very hefty tax bill to our partners at the IRS. And last I looked, they weren’t providing much in the way of flexible payment plans on owed tax. (Nor are the terms very attractive.)
Now to spice this up even more, many borrowers these days have been “nontraditional students”, which is the scholastic industry (and make no mistake, it is an industry despite its largely “not for profit” status) for “old farts returning to school.” So you have people graduating in their 50s who end up on IBR, and at the end of 25 years can have a rather onerous tax liability when they are in their 70s. These are people who likely haven’t worked FT for 10 or more years, and live on SS and perhaps some IRA or 401(k) savings. Now they suddenly are potentially thrust into the highest income bracket at a time when they are on a fixed income and possibly struggling to make ends meet in their so-called “golden years”. (And while likely struggling against the highest health care costs in the world as their physiology wears out.)
I have asked the folks at Fed Loan Servicing about this, and no one (and I have called multiple times and even gone up the chain of command), and I mean NO ONE can give me an answer about what will happen to these people. (Of which I am in their number.) Is there anything that can be done pre-conversion to income that will provide an alternative to death being your best option? And what about spouses who might marry into such situations? Are they destined to an old age of poverty and IRS harassment from a debt that was not theirs in the first place?
Might even be a pink mastodon for that matter…
May 3, 2014
Thanks for the kinds words.
These are fantastic questions.
First, let me say that the answers to your question are hard to pinpoint at this time. We won’t have the first people approaching the 20 or 25 year forgiveness for over a decade, so many of the formalities have not been finalized.
One idea that strikes me… the forgiveness provision likely requires an application. If you don’t apply, its possible that the debt is never forgiven, so you just keep paying on IBR. Again, it is hard to say tat this point… we are a decade away.
Another thing to keep in mind is that many policy analysts see the same problems down the road that you do. The law now as it pertains to forgiveness and IBR could change over the next decade. The arguments that you make are a huge part of the reason that it could.
As for the spouses, they can file their taxes separately for them not to include the two incomes for doing the IBR math. The same can be likely done when the “big year” is counted. Keep in mind, the spouse has no obligation to pays off their significant others student debt unless they are actually a part of the loan.
Thanks for you reply Sherpa.
I don’t think (and I could be wrong, and certainly don’t profess to know as much as you do about the entire scam, er, system) is that the conversion will take place irrespective of an application.
I want to further expand on the spousal aspect: my concern (inasmuch as I am dating a woman who is 13 years younger than myself) is that when the “magic year” occurs, that “income” will be imputed as if I “earned” it in that year, and wil be the responsibility of the couple, even if they have been filing Married but Separate the entire time they were married.
That is to say, if a $200K balance is forgiven, an approximate tax would be owed of $76K (based on the top nominal tax rate at this time, since that 1099 would vault one into the top bracket.) Then the borrower spouse dies a year or 2 later – what is the IRS liability for the non-borrrowing spouse? Even though it was not their debt, the IRS can argue that they materially benefitted from the IBR by having more money availabel in their household, and as such even though they weren’t the borrower incurred a monetary advantage from their spouse. For example, if I were to actually make money working in thata year, and then pass away, I doubt my spouse would be off the hook for the tax on my earnings.
I even spoke to a tax attorney and he wasn’t sure how this would be treated.
I agree with your statement that we haven’t seen how this will play out inasmuch as no one has reached this point to date. It is a classic symptom of poltiican stupidity (and cupidity) to enact a plan, without thinking it through to its logical conclusion. (Politicians in this country must be horrible chess players.) Then they puff out & beat their chest and pretend they are looking out for the little guy. (While the little guy pays 6+% interest on his Federal loans, while the banks that caused most of the financial crisis in this country get theirs at essentially ZERO.)
May 3, 2014
Let me share my reasoning behind the “application” theory. When it comes to public service loan forgiveness, you have to have 120 certified payments in order for your debt to be forgiven. Yet, even when the 120 payments are certified, there is an application that must be completed before the debt is discharged. This additional step seems entirely unnecessary, yet it exists. The same situation could very well exist with IBR and the 25 years.
You also may be able to bounce around repayment plans, REPAYE will be available soon, and it has some pros and cons, but is another income based plan that will be available at that time.
Ultimately, there has to be some legitimate alternative to running into the pink mastodon as you call it. There is no way for people to handle a huge tax year if they are living on a smaller fixed income. That being said, Congress tends to act at the last second, even on matters of great urgency. With us being so far away from anyone facing this situation, they will likely be sitting on their hands for a while.
Sherpa – I have been meaning to post back out here because I have a (harebrained?) idea for those in my situation; i.e., “older” people (late 50s) with enormous student loan balances.
Since the only way to escape a student loan is by dying, what would happen if say 15 years into your 25 years (so for me I would be in my mid to late 60s) if you switched to a different plan (such as the new one that you cite above) – does this start the 25 year clock over again? If so, the odds that I will live long enough to outlive the new loan terms becomes slim, and I can continue on an income based program if I stay current based on my Social Security & the tiny pension I have. In the situation q0-15% of my “disposable income” should be a pittance, and while the loan balance will be skyrocketing, I will almost certainly pass before the end of the new term, assuming it starts the clock over.
It just shows what a sick country we live in when you have to try to plot around your own natural death just to be able to live a life as the result of being stupid enough to get an education in this country.
What thinketh ye?
May 3, 2014
That is a very interesting solution.
Presently, switching between PAYE and IBR is probably rare, but with REPAYE we will probably see far more switching between plans. I’m not sure how the government will track this information, but your approach may work. Because nobody has qualified for student loan forgiveness under either plan, it is hard to say how they will track these things.
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