With the costs of going to college ever rising, students are getting loans to pay part or all of the expense. What is overlooked in the decision to take the loan in the first place is the ability to pay it back or face severe tax consequences.
The worst part of this horror story is that when the loan isn't paid back, the government taxes the amount of unpaid debt as income. Effectively phantom income. It doesn't really exist (except in tax theory), but it's taxable nonetheless.
This was highlighted in a recent tax court case when sometime in the 1980s, the then student borrowed $19,986.72 from the Connecticut Student Loan Foundation (CSLF). In 1988, the CSLF got a default judgment for $27,655.30.
By Dec. 31, 2005, the debt, because of interest, had climbed to $73,258. The student/debtor and the CSLF/creditor made a settlement of $45,000. This was paid and the student/debtor was released.
The satisfaction of judgment was filed in February 2006. This then resulted in the CSLF issuing a 1099-C in 2006, which reports to the IRS the cancellation of debt.
Essentially the facts then are that a Vietnam veteran goes to college and borrows about $19,000. This grows to some $73,258 of debt. He and the creditor settle the debt for $45,000. With the ultimate result that he owes federal tax on what is commonly referred to as phantom income of $27,655.30.
The tax law in this scenario is clearly on the side of the government. Sections 61(a)(12) and 108 both provide for the cancellation of debt income. It's what Congress stuck into the tax law. Everyone who has a loan is stuck with this potentiality.
It strikes me that this is particularly egregious when it comes to student loans. Government policy and pressure is on all high-school students to go to college. College is heavily promoted as the only pathway to success.
To facilitate this for colleges and universities, all levels of government and some private sources, such as some banks, financed this expensive endeavor by offering student loans — to students who didn't have the financial ability to support the loans.
And, of course, the colleges and universities not only go along with the party line but also become fervent supporters of their political benefactors.
All based on some false promotion that by going to college, they will have so much money from a good job that the debt would only be a minor inconvenience.
The reality is that the more money that was made available for student loans, the more that colleges and universities raised their tuition and other costs. The students are just grist for the mill. The money is made by everyone else except the students.
As we see currently, even the prospect for good jobs that were so enticing that students went heavily into debt hasn't become a reality.
Why, you question?
Clearly , Congress — which promoted college and student loans — has so mismanaged economic policy that there are no good high-paying jobs for these masses of people encouraged to borrow heavily to go to college. And the colleges and universities were willing participants since they got their share of the money.
However, the students aren't only left with their own debt, but also the trillions of dollars of debt being racked up by the government. And little or no prospect of having a high-paying job which will enable them to pay the debts.
To add insult to injury, as they say, is the tax that they are hit with when they can't pay back the debt and are stuck with paying tax on phantom income.
The fault lies with Congress and not the tax authorities. It is another example of whatever the government does, it does badly.
It seems to me that every student loan should be carry a highlighted warning in neon orange that borrowing money is dangerous and will result in being taxed if not paid back. That and get government out of the college education business and let the free market work.
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