BILL ANALYSIS                                                                                                                                                                                                    Ó



                                                                            



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                                 UNFINISHED BUSINESS


          Bill No:  SB 1271
          Author:   Evans (D), et al.
          Amended:  8/27/14
          Vote:     21


          PRIOR VOTES NOT RELEVANT

           SENATE GOVERNANCE & FINANCE COMMITTEE  : 6-0, 8/29/14
          AYES:  Wolk, Knight, DeSaulnier, Hernandez, Liu, Walters
          NO VOTE RECORDED: Beall
           
          ASSEMBLY FLOOR  :  Not available


           SUBJECT  :    Personal income tax:  student loan forgiveness

           SOURCE  :     Author


           DIGEST  :    This bill excludes loan amounts repaid by the United  
          States Secretary of Education (SSE) or canceled pursuant to  
          Education Code Section 1098(e) from gross income.  

           Assembly Amendments  delete the Senate version of the bill, and  
          instead add the current language.

           ANALYSIS  :    

          Existing law:

          1.Provides that "gross income" includes all income from whatever  
            source derived, including compensation for services, business  
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            income, gains from property, interest, dividends, rents, and  
            royalties, unless specifically excluded.

          2.Provides that in the case of an individual, gross income does  
            not include any amount which would be included by reason of  
            discharge of any student debt if such discharge was pursuant  
            to a provision of such loan under which all or part of the  
            indebtedness of the individual would be discharged if the  
            individual worked for a certain period of time in certain  
            professions for any of a broad class of employers.

          This bill:   

          1.Excludes, for taxable years beginning on or after January 1,  
            2014, loan amounts repaid by the SSE or canceled pursuant to  
            Education Code Section 1098(e) from gross income.

          2.Takes effect immediately as a tax levy.

           Background

          Federal Income-Based Repayment (IBR) Programs  .  The IBR plan is  
          a repayment plan for the federal student loans made under the  
          Federal Family Education Loan program and the William D. Ford  
          Federal Direct Loan program that allows borrowers to make  
          payments based on their federal student loan debt and their  
          discretionary income.  A borrower qualifies for IBR if he/she  
          has a "partial financial hardship," which may occur if total  
          annual payments, as calculated according to a standard 10-year  
          repayment schedule, are greater than 15% of the amount by which  
          the borrower's adjusted gross income (AGI) exceeds 150% of the  
          poverty line applicable to the borrower's family size.  If a  
          borrower's AGI increases to the point where the borrower no  
          longer has a partial financial hardship, the borrower's monthly  
          payment will increase to the amount that would have been  
          required based on a standard 10-year repayment schedule.  If the  
          borrower has a federal student loan balance remaining after  
          repaying according to the IBR plan of 25 years, the remaining  
          balance will be forgiven.

          In 2010, the IBR program was modified for student borrowing  
          qualified educational loans on or after January 1, 2014.  The  
          threshold to qualify for IBR and setting the maximum monthly  
          payment was reduced from 15% of income that exceeds 150% of the  







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          poverty line to 10% of income that exceeds 150% of the poverty  
          line.  The IBR program was also modified to reduce the IBR  
          repayment program from 25 years to 20 years for new borrowers.

           Taxable/Non-Taxable IBR Loan Forgiveness  .  In general, the IBR  
          program allows borrowers to have their loans forgiven after 20  
          or 25 years, depending on when the loans were taken out.   
          Existing law defines "gross income" as including all income from  
          whatever source derived unless specifically excluded.  Internal  
          Revenue Code Section 108(f) provides that gross income does not  
          include a discharge of student debt if it is dependent upon the  
          borrower working for a certain period of time in certain  
          professions for a broad class of employers.

          Under the Public Service Loan Forgiveness program, individuals  
          are encouraged to enter full-time public service employment by  
          forgiving the remaining balance of their qualifying student  
          loans after they have made 120 qualifying payments while  
          employed full-time by a public service organization or  
          governmental entity.  As such, loans forgiven as part of the  
          Public Service Loan Forgiveness program are not taxable because  
          the program requires a borrower to work for certain employers  
          for a specified period of time.  On the other hand, because the  
          IBR program, by itself, does not require a borrower to work for  
          a specified period of time or for a specified employer, loans  
          forgiven after the 20 or 25 year payment plan are includible in  
          gross income and subject to tax.

           What Does this Bill Do  ?  As noted above, loan forgiveness under  
          one of the IBR programs, by itself, is subject to tax.  This  
          bill excludes, for state tax purposes, loan amounts repaid by  
          the SSE or canceled pursuant to Education Code Section 1098(e)  
          from gross income.  Education Code Section 1098(e) includes all  
          loans covered under the IBR plan.  Providing an exclusion from  
          gross income would allow borrowers to have their loans forgiven  
          after the 20 or 25 year period without paying income tax on the  
          forgiven loan amount.

           Why Now  ?  This bill excludes the discharge of student loan debt  
          under the IBR plan from gross income.  According to the FTB, the  
          first year that qualified student loan debt may be forgiven is  
          2019, and the estimated revenue loss for FY 2018-19 will be  
          $5,000.  Because this bill will have no impact until FY 2018-19,  
          it may be more appropriate to have the bill move through the  







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          normal legislative process instead of amending a bill during the  
          last few days of session.

           Rationale of Taxing Forgiven Debt  .  The practice of taxing debt  
          cancellation reflects sound tax policy because it recognizes the  
          fact that an individual's net worth has increased by the  
          cancellation of debt.  According to Commissioner v. Glenshaw,  
          the Court defined "income" as an accession to wealth that is  
          clearly realized and over which the taxpayer has complete  
          dominion.  (Commissioner v. Glenshaw Glass Co., 348 U.S. 426,  
          431 (1955).)  When debt is cancelled, money that would have been  
          used to pay that loan is now free to be used on whatever the  
          taxpayer wants.  Therefore, because certain assets have been  
          freed, the taxpayer has experienced an accession to wealth.   
          Additionally, under the rule of symmetry, a loan is not  
          considered income to the borrower nor is it a deduction to the  
          lender.  A borrower's increased wealth when the loan is taken  
          out is also offset by the obligation to pay the same amount.  If  
          the debt is cancelled, the symmetry is destroyed.  The borrower  
          is in a much better position after the debt is cancelled.   
          Additionally, as noted by Debora A. Grier, Professor of Law of  
          Cleveland State University, in her statement before the United  
          States Senate Finance Committee, without this tax rule, "the  
          borrower will have received permanently tax-free cash in the  
          year of the original receipt," i.e. the year in which the  
          borrower received the loan.

           Out of Conformity  .  As noted above, California conforms to  
          federal law with respect to the taxability of student loan  
          forgiveness.  In general, state conformity with federal law  
          promotes greater simplicity and eases administration of complex  
          tax laws.  By excluding all loan amounts repaid by the SSE or  
          cancelled pursuant to Education Code Section 1098(e) from gross  
          income, this bill takes California out of conformity with  
          federal law.

           Comments

           According to the author this bill will ensure that California  
          tax law does not penalize taxpayers whose federal student loan  
          debt is forgiven pursuant to federal law.  The author is deeply  
          concerned about the burden that student loan debt places on  
          Californians.  This bill is a modest step toward helping  
          alleviate the crushing, long-term financial burden of a college  







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          education for Californians

           FISCAL EFFECT  :    Appropriation:  No   Fiscal Com.:  Yes    
          Local:  No

          According to the Franchise Tax Board, under the federal  
          income-based repayment programs, the first year that qualified  
          student debt may be forgiven is 2019; thus, there will be no  
          revenue impact prior to fiscal year (FY) 2018-19.  Based on a  
          proration of an estimate prepared by the Joint Taxation  
          Committee, it is estimated that the revenue loss from this bill  
          will be approximately $5,000 in FY 2018-19, gradually increasing  
          to a loss of approximately $100,000 by FY 2023-24.



          AB:e  8/29/14   Senate Floor Analyses 

                         SUPPORT/OPPOSITION:  NONE RECEIVED

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