Taxation of Forgiven Student Loans and Some Observations

President Biden's announcement on August 24 that many individuals with student loan debt would see up to either $20,000 (Pell Grant recipients) or $10,000 (others) forgiven has unsurprisingly received a lot of attention. To qualify, borrowers must have income under $250,000 if MFJ or HH or under $125,000 for all others.  The announcement did not say what this measure of income is (AGI, modified AGI, something else) and for what year. The White House estimates that this income level is about 95% of individuals.

First - what is the tax effect? The American Rescue Plan Act (P.L. 117-58, 3/11/21) modified Code §108(f) to provide that for 2021 through 2025, gross income excludes income from cancellation of higher education student loans. So, for federal purposes, assuming these cancellations of up to $20K or $10K of student loans occurs in 2022 through 2025, no federal income tax is owed.

I have seen a few articles and news reports that some states might tax this income, making it sound like a dreadful result. Certainly, tax-free is better than taxable, but the borrower is still in a better position than paying that principal and interest on their own. For example, if someone with a state income tax rate of 5% has $10,000 of student loan cancellation income and is in a state that taxes that $10,000, they are out of pocket $500.  That's much better than out of pocket $10,000 of principal and the interest on it.

For additional information on this announcement, see:

• White House fact sheet of 8/24/22
• Background Press Call by Senior Administration Officials, 8/24/22
• Explanation from the Federal Student Aid Office in the Dept of Education
• More from the DOE including a link to the 5-page memo on the legality of this debt forgiveness

Next - The significant and growing amount of student debt is a problem. There is no specific plan to address the numerous issues leading to so much student debt in these announcements.  There are a few items noted such as the Department of Education publishing lists of "programs with the worst debt levels in the country," and "requesting institutional improvement plans from the worst actors that outline how the college with the most concerning debt outcomes intend to bring down debt levels" (see the end of the White House Fact Sheet). This won't go far enough.

Per the Federal Reserve Bank of New York, at the 2nd quarter of 2022, individuals held the following aggregate debt amounts:

• Mortgages - $11.39 trillion
• Home equity debt - $320 billion
• Credit card balances - $890 billion
• Auto loan balances - $1.5 trillion
• Student loan balances - $1.59 trillion
• Other - $470 billion
• TOTAL - $16.15 trillion

That is a lot of debt! 

A few observations and questions:

• Why don't we see this large group of borrowers ask Congress why they can't deduct interest annually on up to $750,000 of debt regardless of the debt?  Or stated otherwise, why is the mortgage debt limit so high (far higher than the median home price in the U.S.) and other type of debt is not favored (there is an income-limited and deduction-limited above-the-line deduction for student debt interest).  Caveat: I don't think the mortgage limit should be so large as it is out of lime with what 95% of individuals could qualify for and is an "upside-down" tax subsidy.
• Why no caveats on the debt forgiveness other than the income limit? Why not add a rule along the lines of - if your university was charging tuition above the national average for a state university, it must cover $5,000 of the debt and the government will match the other $5,000 (of $10K for a Pell Grant recipient)? Tuition at many universities is way too high! You can find examples of over $100,000 for an MBA degree.  btw - an MST at San Jose State is $20,000 and this is a high quality program (imho).
• What about financial literacy in high school to help students understand the costs of all types of borrowing and how high debt can affect your future spending needs such as buying a home and raising a family.
• What about finding ways to reduce tuition costs and have universities charging tuition above some specified level to have to handle the lending (and risks) on their own?
• The student loan problem is an awful one caused by the government, universities, lenders and borrowers who may not have had all of the facts or not had the financial literacy education or experience to see the problems of high student loans. If you want to get better insight into all of the problems, I encourage you to read The Debt Trap: How Student Loans Became a National Catastrophe, by WSJ reporter Josh Mitchell.  It changed my view on this to be lean more towards forgiving some of this debt and perhaps all of it for individuals with lower income than what Biden's current plan calls for.  Prior to reading this book, I didn't know the history of how the lending program was started years ago and the perverse incentives that exist to really take advantage of parents and students.  It is awful.  
• Pell Grants should be increased and the money can be found by reducing tax breaks for individuals with income high enough to not need them. Also, more is needed to get more universities to use any large endowments they have (subsidized by all of us via the tax law) to use them to provide opportunities for all who qualify to get a degree.

btw - my 10 years of schooling and three degrees including two from private universities was self-funded while I worked full time. I survived but this isn't for everyone. My first degree from CSU Northridge cost me $100/semester for tuition/fees (books were far more)!  Why does it cost so much more today - about $4,000 per semester at SJSU (although still a bargain in California compared to many other states). Inflation adjusted, $100 in 1980 would be $380 today. This likely isn't a good comparison though because it should have cost more than $100 in 1980 but back then, the state (taxpayers) paid for far more of the costs and I think costs at universities were much lower in 1980 compared to today. But still, how did the cost go up so much more than inflation?

What do you think (about the tax aspects or solutions to avoid debt cancellations in the future)?

How should a virtual currency exclusion work?

A frequent proposal for taxation of virtual currency is to add an exclusion similar to IRC section 988(e) for gain "by reason of changes in exchange rates after such currency" for personal transactions. This is a simplification measure as not records need to be kept such as when one is traveling and using a foreign currency. It is likely infrequent that the conversion gain exceeds $200.

H.R. 6582 (117th Congress), Virtual Currency Tax Fairness Act of 2022, would add section 139J to not include gain up to $200 due to changes in exchange rates, from disposition of virtual currency in a personal transaction (defined per section 988(e)). [also see rationale from the sponsors]

In contrast, the Responsible Financial Innovation Act, introduced by Senators Lummis and Gillibrand in June includes a different version of section 139J. This version says no gains or losses of $200 or less are recognized from the sale or excahnge of virtual currency in a paersonal transaction for goods and services. If the gain or loss is from an exchange of one virtual currency for another and the gain or loss is $200 or less, this exclusion does not apply. [see page 11 of the bill + see sponsor explanation of the entire bill]

So, which is the better version?

I think it is the Lummis/Gillibrand version.  If the purpose of any exclusion is simiplification, it should apply to gains and losses. Otherwise, the individual needs to track records for transactions to see if a loss was generated to be recognized, defeating simplification. Of course, if the virtual currency is only used for personal transactions without any investment intent, the loss of any amount would not be allowed.

And I think the exclusion should only apply when the virtual currency is used to acquire personal goods and services (as with the Lummis-Gillibrand bill).  If the virtual currency is used to acquire another virtual currency, it likely is for investment and all records of gains and losses need to be kept.

What do you think? 

Olympic Winnings Exclusion on to the White House - Don't Sign It!

Continuing with a recent theme in this blog - here is an update on federal legislation to not tax winnings of Olympic athletes.  That is, the value of the medal and the cash from the U.S. Olympic Committee will be tax free.  H.R. 5946 has now passed in the House and Senate, so will soon be off to the White House.

Along the way, a major change was made ... If the Olympic medal winner has modified AGI over $1 million, he has to report the winnings!  This amendment addresses the oddity of giving an exclusion to Michael Phelps and the men's basketball team players and other high-income winners.

As noted in my 9/14 post, this bill only results in a revenue loss of about $3 million over ten years. In our trillion dollar budget, this is nothing. But that is no reason to enact this change.  [also see 8/17 post] Additional reasons not to enact this legislation:

• It is not needed. The winning athletes will have enough money to pay taxes on the winnings because the bulk of the winnings are in cash.
• Some are likely low income and the bronze or silver prize alone might not be enough to put them into a taxable bracket.
• The fact that they incur a lot of costs to participate is no reason for the tax break as this is true of many people. For example, college students spend a lot of money to attend college.
• The fact that they represent the US in the games is a weak justification for the bill. The benefits the athletes receive will benefit them, and the U.S. a lot less (other than from taxes from winnings!)
• If there is a desire to change the law to help those representing the U.S. why not start with the military?
• Adding unnecessary rules to the tax law (we have over 200 of them already) just makes the tax system more complex, inefficient and inequitable.

What do  you think?

Does small revenue loss justify bad tax law? No

More on legislative efforts to give a tax break to winning Olympians(!) ...

See my 8/17/16 post for background.  This post got a lot of comments both here and on Tax Connections.

An update: H.R. 5946, U.S. Appreciation for Olympians and Paralympians Act, would modify §74 to exclude from income the value of medals and prize money received for competition in the Olympic or Paralympic Games. A similar bill, S. 2650, passed in the Senate on 7/12/16. Also see H.R. 2628, Tax Exemptions for American Medalists Act of 2015 (TEAM Act), applicable to awards received after 2014. S. 2650 and H.R. 5946 would be effective for awards received after 2015.

The Joint Committee on Taxation estimates that cost of this bill at $3 million over ten years (JCX-72-16 (9/13/16).

While $3 million cost over ten years is less than a rounding error in the federal budget, this does not justify enacting an unnecessary provision that violates many principles of good tax policy such as equity and neutrality.  Also, will this open the door to others seeking low cost changes to save them taxes? 

What do you think?

Olympic Medal Taxation Craziness

Every four years we usually see at least one bill introduced in Congress to make Olympic medals and related prize winnings (such as cash) non-taxable to the athletes. Why? There is no good reason for excluding this prize income.  All prizes are taxable because they are an accession to wealth which is what our income tax system is based upon. If you win a raffle or win on Jeopardy!, the prizes are taxable. Why should an Olympic medal be different?

Possible reasons offered:

1. The athletes are representing the U.S. Sounds patriotic but the winnings are still income and we could come up with all kinds of reasons to make all income non-taxable if we tried. For example, people who work in hospitals are helping people, perhaps we should exempt their income from tax?
2. The athlete might have to sell their medal to pay the tax. This is weak because the metal value is under $1,000. (See Forbes article by DeMarco for the estimate based on the value of gold and silver today.) Also, the U.S. athletes also get cash from the US Olympic Committee, reportedly $25K for gold, $15,000 for silver and $10,000 for bronze.  Not bad. Yes, they incur a lot of costs to prepare, but so do students earning college degrees and their income is taxed.
3. The athletes are low income.  If they are low income, the tax system will already put them in a zero or very low tax bracket. But they are not all low income. While not all have the estimated $50 million net worth of Michael Phelps (Money magazine article), many do earn a lot of money from sponsorships or employment.

S. 2650 would exempt the value of the medal and cash prizes from the U.S. Olympic Committee. It passed the Senate on July 12 and a version is being considered by the House (H.R. 2628).

California has also joined in this craziness. AB 1944 would exempt the value of Olympic medals and associated cash prizes from California income tax through 2020.

These proposals don't meet most of the principles of good tax policy.  Most importantly, they don't meet the principle of equity and fairness. Olympic medal income is really no different from any other type of taxable income.  There is no reason to exempt it from taxable income.

What do you think?