We are writing a lot about student debt; perhaps because there is so much of it. Last evening United Press International (UPI) reported that the US Education Department was issuing loan forgiveness to 16,000 student loan borrowers because for-profit colleges had misrepresented to students the success of their programs in garnering employment at graduation.
The Department focused on 1,800 students of DeVry University who were told that 90% of student graduates were placed in their field of study within six (6) months of graduating. The government claimed that this representation was false. Other colleges which are under scrutiny include Corinthian, IIT Technical, Globe University and Westwood College. The aggregate debt discharged was $415 million or roughly $25,000 per student.
No matter where you come down on this issue, it creates complications of its own. Under federal law, a taxpayer realizes income to the extent that a debt is cancelled or discharged under Section 61(a)(11) of the Internal Revenue Code. In practical terms if you are a taxpayer affected by this Education Department announcement and you have $25,000 in debt cancelled, the IRS is notified that you have $25,000 in income. You do avoid any of the discharged student loan payments but that $25,000 in income will “convert” to a $5,500 tax liability depending on your other taxable income in 2022.
If that isn’t enough “ouch”, Pennsylvania’s definition of income for purposes of child and spousal support essentially mirrors the federal income tax definition. So, your $25,000 discharge is effectively $19,500 in additional income once you pay the IRS. If you net $3,000 a month in income from your regular job, this discharge will have the effect of increasing your income to $4,600 a month and that means your support for two kids will go up by $400 a month.
The good news remains the fact that you no longer are paying the student debt. The not so good news is that the IRS will be looking for $5,500 and the kids may be getting another $4,800. All well and swell except when you net $36,000 in cash from work, you don’t have a spare $10,300 to spread around to the taxman and your children.
There may be a solution to this but it’s not apparent on its face. There are many complexities and inequities related to how all this debt came about. The federal government needs to sort that out or there will be lots of cash flow issues such as we have just described. The other victim here is the support offices who manage child and spousal support accounts. They are just clearing the many issues created by discharged government emergency loans (e.g. PPP loans) and we have noted that they are now coping with the changes in the child tax credit. The discharge of student debt is another bend in the river dotted with one time events that change income and support.