Federal income-driven repayment plan programs such as Income-Based Repayment (IBR) and Pay As You Earn (PAYE) are imperfect but much-needed plans that allow many student loan borrowers to repay their loans using formulas based on their income and family size. For many student loan borrowers, they are the only affordable repayment plans available, and they help prevent default, which can be disastrous.
These programs also have an important safety net: after completing the plan’s repayment term (25 years under IBR, and 20 years for PAYE), borrowers can get any remaining balance on their student loans forgiven. Most borrowers are expected to repay their loans in full before they reach the end of their repayment term. But if a borrower’s income is insufficient to repay their loans in full, loan forgiveness means they won’t have to spend the rest of their life pouring a percentage of their income into a black hole. There is an eventual light at the end of the tunnel.
But of course, there’s a caveat. Under current law, loans forgiven under income-driven repayment plans like IBR and PAYE can be treated as taxable income for the borrower (the exception is for loans forgiven under the Public Service Loan Forgiveness program). By way of example, let’s say that Barry Borrower has $40,000.00 in federal student loans and goes onto the Income-Based Repayment (IBR) plan. At the end of 25 years, Barry has $10,000.00 left – this balance is automatically forgiven. However, the IRS may require that Barry report that $10,000.00 as “income” on his tax return, which could cause him to incur additional taxes that year.
Lawmakers and policymakers are beginning to appreciate the absurdity of a program that provides decades of relief to people, only to slam them with what may be an un-payable tax at the end. This was not the original intent of these programs, and should not be the end result. Thus Senator Jeff Merkley (D-Oregon) has introduced a bill called the “Income Based Repayment Debt Forgiveness Act,” which would eliminate any tax liability for borrowers who get their loans forgiven under a federal income-driven repayment plan.
Like Senator Elizabeth Warren’s student loan refinancing bill, I unfortunately don’t think Senator Merkley’s bill is going anywhere anytime soon. The current political climate simply does not favor these types of reform measures right now. However, this is not a reason to be pessimistic. I think Senator Merkley’s bill is a sign of the growing recognition that existing student loan programs need serious fixes. After the 2016 presidential election, I am hopeful the climate will be much more conducive to these types of reforms – no matter who gets elected.