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They Think Their Student Loans Will Vanish. There's a Problem

When the 20 years are up, there's a tax bill
By Kate Seamons,  Newser Staff
Posted Jun 27, 2018 2:32 PM CDT
Updated Jul 1, 2018 6:38 AM CDT
In this Sunday, Dec. 17, 2006, file photo, college graduates socialize before their commencement at the Convocation Center in Ypsilanti, Mich.   (Leisa Thompson/The Ann Arbor News via AP, File)

(Newser) – For some 3.2 million Americans who work in the private sector, it has apparently seemed like a good deal: Lock in their monthly federal student-loan payments at 10% of their discretionary income. Make those payment for 20 years (25 if it's graduate school debt, notes Forbes). Hit that date and see whatever is left wiped away—and there might be a ton left, as the payments are often smaller than the interest that's being accrued. The Wall Street Journal reports these "income-driven repayment plans" have been available through the Education Department since 2007, meaning balances won't start going to zero until 2027. And when they do, expect a "bomb." That's because the balance that's forgiven is considered income for that year, meaning the borrower has to pay tax on it.

The Journal does the math: One estimate expects such borrowers to have $41,000 forgiven on average. At a 25% income tax rate, that would mean a $10,250 tax bill. On the more eye-popping end of the spectrum, it references an orthodontist it interviewed who had student-loan debt in excess of $1 million; that associated tax bill could be $700,000. (Forbes notes the Public Service Loan Forgiveness program doesn't levy taxes on the forgiven amount). "I'm very doubtful that everybody is going to be able to make these tax payments," said Constantine Yannelis, who worked in the Treasury Department under Obama. The IRS could place liens on homes or garnish Social Security checks, but some experts expect that as 2027 approaches, Congress will see heavy pressure to act; eliminating the tax could put taxpayers on the hook for billions in student-loan costs. (Read more student loans stories.)

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