Young lawyers could face ‘tax bomb,’ says SMU professor
As attractive as the terms may be, some law-school graduates enrolled in federal student-loan programs could be facing what one law professor dubs a “tax bomb” down the road.
By Jacob Gershman
Thousands of recent law-school graduates have taken advantage of a pair of programs aimed at easing student-debt burdens.
The plans require federal student-loan borrowers to pay back as little as 10%-15% of their discretionary income each month over 20 to 25 years. After that period, any remaining balance is forgiven.
As attractive as the terms may be, some law-school graduates enrolled in the programs could be facing what one law professor dubs a “tax bomb” down the road.
Specifically, it’s set to go off in 2032, the first year when the loans qualify for debt forgiveness. At that point, the forgiven debt turns into “cancellation of debt” income under the tax code, taxed as ordinary income, says Southern Methodist University law professor Gregory S. Crespi.
In a draft paper published online, highlighted by Paul Caron’s TaxProf Blog, the professor estimates what that could mean for a lawyer who wraps up the repayment period with a hefty amount of unpaid debt:
[A] large proportion of those enrollees who have incurred loan debts to finance law school studies will as a result have over $150,000 and perhaps even in some cases as much as $300,000 or more of unpaid principal and accrued interest still owing and then forgiven at the end of the applicable 20- or 25- year repayment period. With such a large amount of forgiven debt included in their income along with their other earnings for that tax year these persons will almost all be paying taxes on that forgiven debt at at least a 28% marginal federal income tax rate, and often closer to a top-bracket 39.6% marginal federal income tax rate, on this additional attributed income. In addition, many states also impose a state income tax on the income recognized by the federal government, in some instances with relatively high upper-bracket marginal rates that would usually here apply given the large size of the debt forgiven.
The two loan programs he’s referring to — the “Income-Based Repayment Plan” and the newer “Pay As You Earn” program — don’t treat law school students differently than other graduate school borrowers. But Mr. Crespi says the high cost of a legal education combined with uncertain future salary prospects for lawyers these days make law school students more vulnerable.
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