BILL ANALYSIS Ó ----------------------------------------------------------------- |SENATE RULES COMMITTEE | SB 1271| |Office of Senate Floor Analyses | | |1020 N Street, Suite 524 | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ----------------------------------------------------------------- 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 CONTINUED SB 1271 Page 2 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 SB 1271 Page 3 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 SB 1271 Page 4 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 SB 1271 Page 5 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 **** END ****