Yikes -- some borrowers could actually see their credit scores go down and their tax bills go up in the year the debt is canceled.
Democratic presidential candidate Senator Bernie Sanders won New Hampshire’s Democratic primary Tuesday, narrowly beating more moderate candidates and easily topping another progressive in the race, Senator Elizabeth Warren.
Sanders and Warren have said their student-debt cancellation plans will help young Americans and their families finally get a fresh start after being buried in debt for so long. Among them: Some borrowers could see their credit scores go down temporarily and their tax bills go up the year the debt is canceled. That’s because credit bureaus may have one less payment source to evaluate a borrower’s creditworthiness.
Both the Warren and Sanders campaigns say they will work to ensure that debt cancellation doesn’t result in larger tax obligations for borrowers. The student-debt cancellation legislation that Sanders co-authored includes a provision stipulating that the amount of a borrower’s eligible federal student loans forgiven by the bill would not be included in their gross income for tax purposes.
If the loan was canceled, the IRS — under current rules — would count that $18,000 as income, bringing the borrower’s total taxable income to $81,000 a year. Depending on what other money the person earned that year, the canceled loan amount could bump them into a higher tax bracket and trigger a bigger tax bill, said Barbara Weltman, an attorney and author of “J.K. Lasser’s Your Income Tax 2020.”
“There are all sorts of ramifications,” Weltman said. Congress would have to pass laws amending the tax code before borrowers could avoid reporting the canceled debt as income, she added. “The IRS does not have authority to say ‘Poof, it’s gone.’” Many of those borrowers may have to pay their tax bills in installments, which could create additional administrative burdens for the IRS, he said.
Instead of applying loan relief to wealthier students, Kelchen said that money could increase funding for Pell grants, which are needs-based grants for low-income student that do not need to be repaid. He said the money could also be used to defray housing costs and child-care costs for students with children.
Having a lower credit score can have significant consequences on people’s financial lives. It can change what types of loans and credit cards a person can qualify for. It also typically leads to a borrower having a higher interest rate. Already millions of Americans are considered “credit invisible,” meaning they don’t have any or enough credit history with one of the three major credit-reporting companies to get a score. A 2015 report from the Consumer Financial Protection Bureau estimated that some 26 million Americans were in this camp.
Warren historically has supported changes to credit scoring and is open to addressing situations where debt cancellation may negatively affect credit scores, a campaign spokeswoman told MarketWatch. Having such a loan removed from their credit profile would almost certainly cause their score to increase. It is not clear, however, whether the borrower’s history of defaulting on the loan prior to its cancellation would remain on their profile.
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