Sunday, May 26, 2013

IBR: The Tax Time Bomb At The End Of The Rainbow

What if there was a way for you to go to law school, take a job in the public sector, and lead a life in line with the American Dream? Philip Schrag and many law schools have just the solution for you: Income Based Repayment (IBR). But, like most things associated with law school, IBR has a dark side that interested parties don’t want students to know about.

Philip Schrag’s paper “refuting” Brian Tamanaha’s Failing Law Schools presents IBR as a great way to make law school more “accessible”, which is a red herring that can be quickly dispatched. The reason we have a lawyer shortage isn’t because we don’t have enough lawyers. It’s because tuitions that are skyrocketing every year can’t be serviced by a public sector salary. Schrag’s paper makes the worst type of self-serving argument. He argues that IBR nullifies the tuition crisis. He wants taxpayers to subsidize law schools, with no checks on the rising tuition. He wants taxpayers to pay his salary, which I am sure he doesn’t want decreasing anytime soon.

IBR is being pitched by law schools as a way to make law school more affordable to all. Several law schools proudly display information about IBR on their websites. On its face, IBR is a very attractive program. Students who have a partial financial hardship qualify. The government qualifies borrowers for partial financial hardship "if the monthly amount you would be required to pay on your IBR-eligible federal student loans under a 10-year Standard Repayment Plan is higher than the monthly amount you would be required to repay under IBR". Given that the majority of law graduates don't make enough money to service their debts, we can assume that almost all law graduates not in BigLaw moving forward will be eligible for this program.

What IBR’s proponents don’t want to publicize is the tax liability that waits at the end of the IBR period. The amount of the loan amount forgiven is treated as taxable income by the IRS. So, let’s say that you have $230,000 forgiven as a result of IBR. Let’s also assume that even after 25 years, you are still only making $45,000 per year because of the law schools still pumping out 44,000 graduates per year every year. If we are to use the tax laws in place today, and add in the standard deduction and 2 kids, that leaves you with a tax bill of $60,463. That’s right: you would owe almost $15,000 more than your annual income in taxes. It’s one last way for law school to ruin your financial well-being.

15 comments:

  1. My understanding is that there is a proposal to change this tax liability for IBR made by the Obama administration, but please correct me if it is someone's else proposal. This may be part of the budget bill, but please comment if you know more.

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    1. Someone please answer this. I bet this is true. Without this tax-fix, IBR/public service for law grads is a horrible idea. This same tax fix was given temporarily to homeowners who got their mortgage cancelled (I believe that it expired). Talk about special interest giveaways.

      --Jim

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    2. The proposal was in Obama's 2014 budget proposal, but since Congress hasn't passed a budget since 2009, it's effectively tabled for now.

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  2. Assuming the IBR term is 25 years, and if IBR came about in 2009, then when will the very first person become eligible for a discharge along with the tax bill? In 2034?

    I say assuming 25 years because I have heard of 20 year periods under IBR. It is all so confusing.

    Also another question: Is there also a tax bill at the end of 10 years of Public Service Loan Forgiveness?

    And a final question:

    Does one missed payment negate the whole IBR or PSLF arrangement or "deal"?

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    1. Another question - this is all for future law grads, right? Those of us who were really caught in the scam (2000-2010 grads) get nothing.

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    2. Unfortunately, you are correct. This program is only for recent grads.

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    3. 1:07PM:

      Per this document, if you miss payments, you are not automatically terminated from IBR. But, the lender may be able to report the missed payment to the credit bureaus.

      As far as I have seen, IBR is a 25 year program. I have not seen any mention of a 20 year repayment period.

      For PSLF, the forgiven balance is not taxable, which makes it a much more attractive program.

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  3. How does one dispatch a herring?

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  4. if a student graduates college at 21, plus 3 years of law school, the earliest he can start working is 24, which in reality is probably closer to 25 or 26. Then we add 25 years, so the earliest present is a tax bomb at 50.

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    1. Just had a $2500 tax bomb on my recent 1040. The IRS does not fuck around. They will collect those taxes with fury.

      A $60000 tax bomb is a killer, especially at that age, just when you think you're getting settled for retirement.

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    2. ^ Pffft, with the way things are going, $60,000 will probably be the hourly minimum wage in 2034.

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    3. Agreed. The federal reserve is printing 80 billion dollars per month laundered through primary dealer banks to the federal government for spending money. The clocks running; this can't got on forever, and it certainly cannot go on for a 25-year repayment period. The jigs up soon enough.

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  5. I would think that the idea of - or the risk of- 25 years of debt followed by an insidious tax bomb at age 50 would scare off the young lemmings in droves.

    As for the nontraditional students: In the not too distant future are there going to be a lot people in their 70's walking around with either student loan debt or the tax (time bomb) bill from their discharged sl debt?

    BTW, this post is probably one of the most important and thanks.

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  6. The real problem with IBR is the fact that it imposes a period of 25 years of servitude. To a 22-year old person maybe that does not sound so terrible. But it is terrible to be in debt in your 30s when things like marriage, home-ownership, elder-care for parents, and children are banging on your door. Let's not even discuss the unmentionable horror of student loan debt in your 40s and 50s when your children need you to help pay them for their education.

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