BILL ANALYSIS Ó PURSUANT TO SENATE RULE 29.10 SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: SB 1271 HEARING: 8/29/2014 AUTHOR: Evans FISCAL: Yes VERSION: 8/27/2014 TAX LEVY: Yes CONSULTANT: Bouaziz PERSONAL INCOME TAX LAW: CANCELLATION OF INDEBTEDNESS: STUDENT LOAN FORGIVENESS. Excludes loan amounts repaid by the United States Secretary of Education (SSE) or canceled pursuant to Education Code Section 1098e from gross income. Background and Existing Law When a lender cancels a borrower's debt, federal and state law generally treats the amount of debt cancelled as income taxable to the borrower. Taxpayers do not include borrowed funds in income in the year he or she receives loan proceeds because of the obligation to repay the loan; the taxpayer is financially no better off because the loan must be repaid. When lenders reduce the repayable amount, the taxpayer realizes a gain in his or her financial situation because a portion of the loan proceeds already received and not previously taxed need not be repaid, thereby increasing the taxpayer's net worth. The taxpayer's income has increased by the amount forgiven plus interest. Specifically, in the case of student loan forgiveness, the amount forgiven generally represents taxable income for income tax purposes in the year it is cancelled with some exceptions. Generally, student loan forgiveness is excluded from income if the forgiveness is contingent upon the student working for a specific number of years in certain professions. When the student participates in public service loan forgiveness, teacher loan forgiveness, law school loan repayment assistance programs and the National Health Service Corps Loan Repayment Program, cancelled debt is excluded from income. However, loan discharges for closed schools, false certification, unpaid refunds, and death and SB 1271 -- 08/27/14 -- Page 2 disability is taxable income. The forgiveness of the remaining balance under the federal income based repayment program (IBR) after 25 years in repayment is considered taxable income. In 2010, Congress modified the IBR program for students borrowing qualified educational loans on or after January 1, 2014. The IBR program was modified to reduce the IBR repayment program from 25 years to 20 years for new borrowers. Proposed Law Senate Bill 1271 excludes from gross income loan amounts repaid or forgiven by the United States Secretary of Education (SSE) under the federal 25 or 20 year income based repayment plan. Senate Bill 1271 applies to taxable years beginning on or after January 1, 2014 and as a tax levy takes effect immediately. State Revenue Impact According to the Franchise Tax Board (FTB), under the federal income-based repayment programs, the first year that qualified student debt may be forgiven is 2019, so, there would be no revenue impact prior to fiscal year (FY) 2018-19. Based on a proration of an estimate prepared by the Joint Committee on Taxation, FTB estimates that the revenue loss from this bill would be approximately $5,000 in FY 2018-19, gradually increasing to a loss of approximately $100,000 by FY 2023-24. Comments 1. Purpose of the bill. According to the author, "SB 1271 will ensure that California tax law does not penalize taxpayers whose federal student loan debt is forgiven pursuant to federal law. Senator Evans, sponsor of SB 1271, is deeply concerned about the burden that student loan debt places on Californians. SB 1271 is a modest step toward helping alleviate the crushing, long-term financial burden of a college education for Californians." 2. Reverse Nonconformity. California law does not SB 1271 -- 08/27/14 -- Page 3 automatically conform to changes to federal tax law, except under specified circumstances. Instead, the Legislature must affirmatively conform to federal changes. Generally, when the federal government changes its tax laws, California catches up by enacting its own legislation the following year to reduce differences between the two codes, thereby easing the tax preparation burden on taxpayers, tax preparers, and the Franchise Tax Board. Currently, California is in conformity with federal law with regard to student loan debt forgiveness. If SB 1271 becomes law, taxpayers would exclude from income the forgiven loan for state tax purposes, but include it for federal tax purposes. 3. Forgive me. A student currently participating in the 25 or 20 year IBR program must make payments based on a percentage of their income. After the 25 or 20 year period of payments, the remaining amount of the unpaid loan is cancelled. Under current law, the year the debt is cancelled, the amount cancelled is taxable income. SB 1271 would excuse cancelled debt for state purposes, thereby reducing the student's California tax liability. 4. Incentivizing non-payment. Cancelling a student loan debt at the end of the 25 or 20 year IBR program may incentivize students to pay as little as possible, even if payment of the entire debt is possible for some individuals. What motivation will a student have to pay off the loan completely if they can simply make minimum payments and have the debt cancelled without any state tax ramifications? 5. Gut and amend. Prior to August 27, 2014, SB 1271 was a measure that prohibits the search of information contained in a portable electronic device. Recent amendments removed those provisions from the bill and inserted the measure's current contents. 6. Why Now? As noted by the FTB, the first year debt may be forgiven is 2019, so it is unclear why this bill needs to makes its way through the legislative process in the last few days of session and not through the normal legislative process. Assembly Actions SB 1271 -- 08/27/14 -- Page 4 Assembly Revenue and Taxation9-0 Assembly Floor 65-3 Support and Opposition (08/28/14) Support : None received. Opposition : None received.