What this bill does: Currently, the IRS counts waived student loan balances as income. The Relief for Underwater
Student Borrowers Act would allow borrowers who have been granted debt forgiveness as a result of consistent
payment through one of the Department of Education’s Income Based Repayment Programs relief from being taxed
on the amount forgiven.
Who would be affected by this bill: Any borrower who is participating in a loan forgiveness program including
Pay as You Earn (PAYE) and the Income Based Repayment Program (IBR). There are currently 1.44 million
individuals enrolled in IBR and 190,000 individuals enrolled in PAYE. According to the Consumer Financial
Protection Bureau, about ¼ of the American workforce may be eligible for repayment or loan forgiveness programs.
Many of the individuals on repayment plans are struggling to make ends meet and taxation on the amount of the
forgiven loan further strains their situations. Any borrower eligible for loan forgiveness would have made monthly
payments for a period of at least 20 years.
Context: Earlier this year, President Obama formally widened the pool of eligible participants in the Pay as You
Earn program (PAYE) helping an estimated additional five million people manage their student debt. The revised
program caps monthly loan payments at 10 percent of discretionary income, defined as income exceeding 150
percent of the federal poverty level for a single person. While the President’s efforts at making loan repayment
more feasible for borrowers are laudable, the relief of PAYE and IBR’s debt forgiveness may come with a
significant tax liability.
The New York Times recently used this example to illustrate this point:
“A single college graduate earning $46,900 a year through full-time work who will have an annual income increase
of 5 percent. She has borrowed $100,000 and is charged 6.8 percent interest. According to the federal Repayment
Estimator calculator, if the graphic designer meets her payments each month for 20 years (at 10 percent of her
discretionary income plus interest, her payments would start at $245 in her first month of repayment and reach
$717 by her last), the federal government will forgive nearly $130,000 of her remaining debt plus interest accrued
over time. In total, she will pay $106,581.
But there’s a catch. The relief of PAYE’s debt forgiveness can come with an onerous tax liability. It appears our
graphic designer saves $129,419 thanks to the 20-year forgiveness stipulation, but because her chosen profession
does not qualify for the Public Service Loan Forgiveness program, her “forgiven” debt could qualify as taxable
income. In short, the designer’s annual income taxes could nearly double in the final year.”
In this example, not only will the borrower be taxed on the forgiven loan, but her gross income for the year would
likely bring her into a different income bracket for the year.
Precedent: Following the housing crisis, Congress allowed for a tax exemption for mortgage debt forgiveness
through the Mortgage Debt Forgiveness Tax Relief Act. Given the extent of the student debt crisis, it is essential we
give borrowers who have been crushed by student debt the opportunity to contribute productively to our economy.
Why This Bill Is Important: Individuals enrolled in loan forgiveness programs have demonstrated a good faith
commitment to paying their loans over a period of time. Many of these borrowers are “underwater” as a result of
their debt and further penalizing these borrowers by adding the forgiven debt amount to their taxable income will
only further economic instability. A recent editorial in the Washington Post advocated for this policy as a part of
many other common sense legislative solutions to help alleviate the student loan debt crisis and the New York Times
has also covered this issue.