The Personal Income Tax Law provides for various exclusions from gross income, including an exclusion for the amount of student loan indebtedness repaid or canceled pursuant to a specified federal law.

This bill would exclude from gross income the amount of student loan debt discharged on or after January 1, 2015, of an eligible individual who was entitled to specified disability benefits or who provides a specified certification of disability with the Franchise Tax Board, as provided.

This bill would take effect immediately as a tax levy.

Date of Hearing: May 11, 2015

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Philip Ting, Chair

ABPCA Bill Id:AB 1055

Author:Baker – As Introduced Ver:February 26, 2015

Majority vote. Fiscal committee. Tax levy.

SUBJECT: Personal Income Tax Law: exclusion: student loan debt forgiveness: disability and blindness.

SUMMARY: Provides that gross income does not include discharged student loan debt if the individual is disabled or blind. Specifically, this bill:

1. Defines an “eligible individual” as an individual who meets either of the following during the taxable year:

   1. The individual is entitled to benefits based on blindness or disability under the federal Social Security Act, Title II or Title XVI; or,

   2. The individual files a disability certification with the Franchise Tax Board (FTB).

2. Defines a “disability certification” as a certification that satisfies the FTB and provides both of the following:

   1. The individual has a medically detrimental physical or mental impairment that results in marked and severe functional limitations that can be expected to result in death, a medically determinable physical or mental impairment that has lasted for a continuous period of not less than 12 months, or is blind, within the meaning of the federal Social Security Act Section 1614(a)(2); and,

   2. A copy of the individual’s diagnosis relating to the individual’s relevant impairment signed by a physician meeting criteria of the federal Social Security Act Section 1861(r)(1).

3. This section shall apply to discharges of indebtedness occurring on or after January 1, 2015.

4. Takes effect immediately as a tax levy.

EXISTING LAW:

1. Provides that “gross income” includes all income from whatever source derived, including compensation for services, business income, gains from property, interest, dividends, rents, and royalties, unless specifically excluded.

2. Provides that forgiven student loans are excludible from gross income in certain circumstances. However, no specific exclusion from gross income for student loans that are forgiven on account of an individual’s blindness or disability.

3. Provides that in the case of an individual, gross income does not include any amount which would normally be included by reason of discharge of any student loan made by a qualified lender if the discharge was pursuant to a provision 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. (Internal Revenue Code (IRC) Section 108(f).)

4. Provides that cancellation of an individual’s student loan is not excludible from gross income if the loan was made by an educational institution and is canceled because of services the individual performed for the educational institution or other organization that provided the funds.

5. Provides that the amount of an individual’s cancellation-of-indebtedness income resulting from a cancelled student loan may be excluded from gross income if the individual is insolvent. The amount excludible from income is limited to the extent of the individual’s insolvency.

FISCAL EFFECT: The FTB estimates General Fund revenue loss of $19 million in fiscal year (FY) 2015-16, $12 million in FY 2016-17, and $12 million in FY 2017-18.

COMMENTS:

1. Author’s Statement: The author has provided the following statement in support of this bill:

[AB] 1050 would exempt, for tax purposes, from California gross income any student loan debt that is forgiven for disability or hardship.

2. Arguments in Support: Board of Equalization (BOE) member, 1^st District, states that "AB 1055 addresses an issue brought to my attention by a constituent last November. She disclosed that she suffered a disability after graduating and incurring her student loan debt. Since her only source of income was Social Security, she applied for debt forgiveness and was approved for cancellation of her remaining debt. Understandably, she was surprised to receive a 1099-C form for the full amount forgiven ($55,000). This created both a federal and state tax liability, and the following year her monthly Social Security check was reduced based on the additional "income" shown on her tax return. Unfortunately, she continues to pay off this debt."

3. 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 rules of symmetry, the 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 at Cleveland State University, in her statement before the United States Senate Committee on Finance, 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.

4. Insolvency: Cancellation of debt is not included in income to the extent the taxpayer is insolvent immediately before the debt is cancelled. A taxpayer is insolvent immediately before the cancellation of debt to the extent that the amount of total liabilities exceeds the fair market value of all assets immediately before the cancellation. This provision may be used in lieu of an exclusion of student loan debt from gross income. It is important to remember, however, that the exclusion applies only to the extent of insolvency. As an example, assume a taxpayer has discharged debt of $5,000. Before the cancellation of debt, the taxpayer had $10,000 in liabilities and the fair market value of all assets is $7,000, meaning that before the cancellation, the taxpayer was insolvent to the extent of $3,000 (total liabilities minus fair market value of assets). Therefore, the taxpayer may exclude $3,000 from income and include $2,000 as income of the discharged debt.

5. What Does this Bill Do? This bill provides that a discharge of student loan debt will not be included in gross income if the individual qualifies for Social Security Income (SSI), Social Security Disability Insurance (SSDI), or upon satisfaction of the FTB. SSI is a program that pays monthly cash benefits to adults who are blind, disabled, or over the age of 65. To qualify for SSI, a person must have no more than $2,000 worth of assets. If a taxpayer were to have his/her student loans forgiven while on SSI, most of the forgiven debt would be excluded from gross income because the taxpayer would be insolvent. Under SSI, a taxpayer with $55,000 worth of liabilities and $2,000 worth of assets would be insolvent to the extent of $53,000.

Other than SSI, the criteria established by this bill do not consider an individual’s ability to pay. Specifically, eligibility under SSDI is based on the condition of the individual and his/her work history. Similarly, the third provision of this bill, namely the proposed certification, only needs to show that a person has a medically detrimental physical or mental impairment that can result in death, has a disability that has lasted for a continuous period of not less than 12 months, or is blind. The Committee may wish to consider the appropriateness of providing an exclusion from gross income to an individual who potentially has sufficient income and assets to satisfy his/her tax liability.

6. Delegation of Authority: This bill grants the FTB with the discretion to provide an exclusion from gross income for the discharge of student loan debts upon the filing of a “disability certification.” A disability certification requires a showing that the person is blind or disabled. However, the “disability certification” must also satisfy the FTB. The guidelines needed for satisfying the FTB are not provided. As such, the FTB may be able to deny a claim even after an individual provides documentation of a disability. By failing to specify clear criteria for granting the exclusion, this bill may constitute an unlawful delegation of legislative authority.

7. Out of Conformity: As noted above, California conforms, in general, 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 loan amounts cancelled due to a disability, this bill would take California further out of conformity with federal law.

REGISTERED SUPPORT / OPPOSITION:

Support

California State Student Association

Member, State Board of Equalization, District 1

Opposition

None on file

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098