It has not actually happened but last month the administration announced its intention to confer discharges of up to $10,000 in student debt for individuals earning less than $125,000 or couples earning up to twice that amount. The discharge can be $20,000 in the case of Pell Grant recipients. This has produced another political barfight and as we have come to learn the best bar to fight in is the “bar” of the courts. So, whether and when the President’s plan takes effect remains a mystery for now. This has been coming. We wrote about it on February 17 of this year, but this is a new program.

            Less of a mystery is the effect of this on support orders in Pennsylvania. Under the Commonwealth’s support law, “income” for support purposes includes income from discharge of indebtedness. This definition parallels the federal income tax law found at 26 U.S.C. 61(a)(11).

            What does this mean for the “average Americans” who may see such a discharge. Let’s run a couple examples. Mom and Dad have split and Mom has 60% custody of two kids. Mom nets $3,000 a month and Dad $6,000. At combined net of $9,000 basic support is $2,152 and Dad has 2/3 of the income so he pays .666 x 2,152 or $1,433 a month. If spousal support is part of the equation, it looks like this:

Dad                 6,000 x .33                              1,980

Mom               Minus   3,000 x .40                 1,200          =      $780

            That $780 spousal support number is added to Mom’s income putting her at $3,780 and subtracted from Dad’s as payor bringing him down to $5220. That changes his child support to 58% of the $2,152 reducing it to $1,248. Thus, all in, his monthly support for Mom & kids is 2,028.

            But, suppose the Biden Plan is upheld and Dad gets his debt cut by $10,000. That would appear to raise his monthly net for 12 months by $833. This pushes combined net income to $9,833. Once again, we do spousal support first:

            6,833 x.33                               2,255

            Minus 3,000 x .40                   1,200               =     $1,055

The additional $833 in Dad’s income because of the loan forgiveness pushes combined net income to $9,833 and that means the child support to be allocated is now $2,248. Mom’s $3,000 income is now augmented with $1,055 in spousal support rising to $4,055 while Dad’s $6,833 is reduced by the spousal support leaving him with $5,778. His share of income is now 58.7% which is multiplied against the $2,248 making child support $1,321 and the whole monthly payment $2,376.

Not to take Dad’s side here but that discharge did not increase his cash flow by a cent. But his cash flow will be dinged for $348 a month and that is before we tack on things like health insurance costs, day care contributions and the inevitable braces.

In fairness, let’s run it the other way and put the discharge in Mom’s column. Her net rises to $3,833. This will reduce her spousal support. $2,255-1,533 means the spousal support declines by $58 to $722. When we do the child support she has 3,000 in compensation, $722 in spousal support and phantom income from the loan forgiveness of $833 summing to $4,555. Dad’s net is $6,000 less the $722 spousal support or $5,278. Combined nets are $9,833 and the child support is still $2,248 but now Mom is bringing home a theoretical 46% of combined household income in contrast to 41.3% if we did not consider the debt discharge income. Dad’s child support is 54% so he will pay $1,214 plus his $722 in child support for a total hit of  $1,936. Again, her actual “cash flow” is no different than in the first scenario presented but the discharge is going to ding her support by $92 a month.

We could run this with both parents getting a discharge but that seems a touch extreme. The moral of this story is that if there is day care and $5,000 for some braces a parent could be paying $500 a month more over the standard amount purely because he or she had the “good fortune” to secure a debt deduction under the President’s plan. In one sense it could be said that this is going to a worthy cause, but it may actually exceed the carrying cost of the $10,000 discharge itself.

N.B.  The White House Fact Sheet published on August 24, 2022 indicates that under the 2021 American Rescue Plan the discharges are not taxable at the federal level. Alas, that would not appear to change Pennsylvania’s Section 4302.