How to calculate the IBR tax consequences Forum

[Tiago Splitter]

It turns out we got a little too excited about the forgiveness stuff. You'll be taxed on the lesser of 1) the amount forgiven or 2) your solvency after the forgiveness

Ok got it

Is there any decent tax advantaged means for saving for the tax bomb?

Probably just a 401k loan, assuming your plan offers them and they still exist in 20 years. You can only borrow 50% up to 50k but maybe that will go up by 2035.

[AVBucks4239]

The main reason I think everyone should go on PAYE initially with big debt is because interest does not compound, and something like 90% of your payments are initially interest. Paying down interest that doesn't compound really doesn't have a benefit for now as opposed to later. Also, building assets with SA year and stub year as your price point for PAYE repayment is clutch.

AV - I think you should really reassess your loan repayment choices here.

Re-read this thread because I'm bored at work and trying to make sure I'm not being an idiot with my loans.

To be clear, I'm actually enrolled in IBR. My payment on 12 total loans is $78.05 per month. I pay that amount and then pay somewhere between $900-1200 on my highest interest rate loan (a 7.65% grad plus loan). So I'm actually taking huge chunks out of my highest interest rate loans and hoping to have them paid off within three years, then move to the lower interest rate loans, etc.

[Kronk]

I mean the tl;dr of it is that paying off your loans the old-fashioned way makes a lot of sense if you can do it comfortably, and may give you a lot of peace of mind in case PAYE gets axed or something, but assuming that everything stays as-is, most people will end up paying way more under a traditional repayment plan than they would with PAYE.

[lacrossebrother]

Here I made a calculator that you can fuck around on. It's pretty poorly organized right now, but the main inputs should be income and 401k contribution on the first page, and then on the paye workbook, your loan information.

You can fuck around with the income growth only by doing it on the year by year part (i did 5% for the first 7 years I think then 2% after)...then some of the other growth rates you'll see throughout.

Let me know if it's too confusing this way and I'll try to rework it to be neater. But i think if you see where the necessary inputs are, you might find it useful.

One of the best features I think is that it allows you to calculate, for a given expected return rate, how much you should contribute to a stock portfolio each month for 20 years to have saved up to pay off the Tax Bomb at the end. You did that on the first page.

http://cl.ly/2i2b0r1x3e0R
edit: I tried to strip author info. Would you guys let me know if i'm outing myself?
Thanks

[Tiago Splitter]

I dont see any personal info

[lacrossebrother]

Thanks

[Johann]

It turns out we got a little too excited about the forgiveness stuff. You'll be taxed on the lesser of 1) the amount forgiven or 2) your solvency after the forgiveness

You're taxed on the lesser of. This is just a protection for the debtor. This doesn't help the government.

[lacrossebrother]

If that's true, should we be getting online MBAs right now and maxing our debt?

[Tiago Splitter]

It turns out we got a little too excited about the forgiveness stuff. You'll be taxed on the lesser of 1) the amount forgiven or 2) your solvency after the forgiveness

You're taxed on the lesser of. This is just a protection for the debtor. This doesn't help the government.

I was just saying we got too excited after looking at that insolvency worksheet. We always knew that if you stayed poor you'd be fine, but I thought you might be able to avoid any tax as long as your debt stayed above your assets. Turns out the government just uses weird language and the old view that only poors avoid taxes was true.

Ultimately anyone in biglaw or making decent money over 20 years will probably have to face the full tax consequences of forgiveness.

If that's true, should we be getting online MBAs right now and maxing our debt?

Only if you know that after 20 years you aren't gonna have much in assets anyway, which seems like a pretty sad thing to know.

[Johann]

I was just saying we got too excited after looking at that insolvency worksheet. We always knew that if you stayed poor you'd be fine, but I thought you might be able to avoid any tax as long as your debt stayed above your assets. Turns out the government just uses weird language and the old view that only poors avoid taxes was true.

Ultimately anyone in biglaw or making decent money over 20 years will probably have to face the full tax consequences of forgiveness.

I mean I still think with section 108(a)(1)(B) combined with the debt worksheet, our original analysis still applies. I don't know the rules of PAYE, but I don't think they can trump the tax code.

[Tiago Splitter]

I was just saying we got too excited after looking at that insolvency worksheet. We always knew that if you stayed poor you'd be fine, but I thought you might be able to avoid any tax as long as your debt stayed above your assets. Turns out the government just uses weird language and the old view that only poors avoid taxes was true.

Ultimately anyone in biglaw or making decent money over 20 years will probably have to face the full tax consequences of forgiveness.

I mean I still think with section 108(a)(1)(B) combined with the debt worksheet, our original analysis still applies. I don't know the rules of PAYE, but I don't think they can trump the tax code.

Look at the examples in Pub 4681

Example 1—amount of insolvency more than canceled debt. In 2014, Greg was released from his obligation to pay his personal credit card debt in the amount of $5,000. Greg received a 2014 Form 1099-C from his credit card lender showing the entire amount of discharged debt of $5,000 in box 2. None of the exceptions to the general rule that canceled debt is included in income apply. Greg uses the Insolvency Worksheet to determine that his total liabilities immediately before the cancellation were $15,000 and the FMV of his total assets immediately before the cancellation was $7,000. This means that immediately before the cancellation, Greg was insolvent to the extent of $8,000 ($15,000 total liabilities minus $7,000 FMV of his total assets). Because the amount by which Greg was insolvent immediately before the cancellation was more than the amount of his debt canceled, Greg can exclude the entire $5,000 canceled debt from income. When completing his tax return, Greg checks the box on line 1b of Form 982 and enters $5,000 on line 2. Greg completes Part II to reduce his tax attributes as explained under Reduction of Tax Attributes, later. Greg does not include any of the $5,000 canceled debt on line 21 of his Form 1040. None of the canceled debt is included in his income.

Example 2—amount of insolvency less than canceled debt. The facts are the same as in Example 1 except that Greg's total liabilities immediately before the cancellation were $10,000 and the FMV of his total assets immediately before the cancellation was $7,000. In this case, Greg is insolvent to the extent of $3,000 ($10,000 total liabilities minus $7,000 FMV of his total assets) immediately before the cancellation. Because the amount of the canceled debt was more than the amount by which Greg was insolvent immediately before the cancellation, Greg can exclude only $3,000 of the $5,000 canceled debt from income under the insolvency exclusion. Greg checks the box on line 1b of Form 982 and includes $3,000 on line 2. Also, Greg completes Part II to reduce his tax attributes as explained under Reduction of Tax Attributes, later. Additionally, Greg must include $2,000 of canceled debt on line 21 of his Form 1040 (unless another exclusion applies).

In example 2 having 10k liabilities before the cancellation and only 7k assets looks like insolvency, but Greg still has to pay tax on 2k.

Wait now I think I'm slightly off with my earlier post but I've been drinking all day so help me out.

If a guy has 400k debt and 250k assets I guess he'd only be taxed on 150k which might not be as bad. But again help me out.

[lacrossebrother]

Ok it works like this:
1. Calculate insolvency. +net worth is never insolvent.
2. Do cancellation minus insolvency number.

So if you have 1 million dollars in student loan, and $500k in assets, you are insolvent $500k. So then you get a million cancelled. Taxed on $500k. (1mio-500k)

Basically, the student loans help you out on one side of the equation, and fuck you harder on the other side.

Theres nothing good that comes from taking more debt, like doing a mba for no reason.

[Tiago Splitter]

I see my problem is that Greg only had 5k forgiven not all 10k of his liabilities

[Johann]

Yeah you were right pre-drinking and I was wrong on page 2. I see now. I still think PAYE for at least the first 2-5 years and accruing assets gives you a lot of planning options down the road for a fairly cheap insurance plan.

[Kronk]

Honestly JdeM is right. Paying your loans off like a good ole boy may quell your fear, but if you manage to save like 50-100k in your first 5 years of PAYE (in addition to contributing to your 401K) and you invest it properly, you've basically already taken care of the tax bomb on say, 500k of forgiveness, and then you have 15 years to accumulate more assets. Even if you're taxed on the full amount, you'll have a lot more coming out than you would if you were paying $2,500 on your loan every month.

[Tiago Splitter]

Oh yeah I'm definitely doing PAYE for a while. Mostly just an excuse to spend more money but I also have no idea where I'll be a few years down the road.

[AVBucks4239]

This thread makes me re-consider my loan payment strategy on a weekly basis.

Strategically use IBR? That will let me save for a house and save/invest a shitload of money in my 401k and brokerage account. Fun!

But wait...what if I start making a lot more money? Won't I end up paying off the loans anyway, but at a much higher cost? And won't I lose a ton of deductions by filing separately?

Ya...but if I used IBR, I could get my money in investments and enjoy the fruits of compound interest (which crushes simple interest of student loans). Then I could build my assets and be pretty close to retiring once I pay my tax liability.

True...but that seems like a big risk. What if the economy tanks right before my tax liability comes due? And then I have to pull $100k from it to pay that tax? Retirement savings crushed at age 52. Yikes.

But is that a risk worth taking considering I could enjoy life instead of slaving away towards my loans in my late 20s/early30s? Maybe.

And if I aggressively pay off loans, I probably won't be doing much saving (i.e., more than 3%) towards retirement until I'm 35 (in the best case scenario).

Sure, but the student loans will hang over your head for 20 fucking years. Christ that's a long time.


On and on, it never ends. I need a Prozac and a Guinness every time I think about this stuff. But I think I've decided that I'm a pretty risk averse person and can't imagine myself making every financial decision within the confines of "How will this affect my PAYE/IBR?"

So I'm just paying my loans off like a good ole boy and hoping for the best. Life goals (age 27):

Buy a house at 30
Pay off student loans at 35-37
Pay off house at 45
Retire by 55

Seems doable for me. And I know I'm beating the living shit out of a dead horse with a meat cleaver here, but I just feel like aggressively paying off my loans gives me more control of the situation while giving me good financial habits that will hopefully stay with me once I'm done paying off loans.

Wish me luck.

[Kronk]

Retire at 55? What are you, an oil tycoon?

[AVBucks4239]

Retire at 55? What are you, an oil tycoon?

Haha, no. But I'm that annoying friend that will drive a used Honda Civic/Ford Focus/Toyota Camry his whole life, live in a smaller house, send my kids to public school, only go on vacations with perks/bonuses, etc. And that more frugal lifestyle not only frees up more money to invest, but it also means you need less money to retire.

Thus, once I'm done paying off my loans, I plan to put significantly more money towards retirement and my mortgage.

And once I'm done paying off my mortgage, then my only real expenses will be property taxes, utilities, car insurance/fuel, and kids. And since I expect my GF and I to have a dual income of around $150-200k at that time, we will be able to put a ton of money towards retirement every year for almost a decade, which should allow us to retire at a pretty young age.

This is a good article on the math of everything (http://www.mrmoneymustache.com/2012/01/ ... retirement) and what percentage of your income you need to save in order to retire at a particular age.

[jamesturnbow]

Hi everyone,

Thanks for the informative discussion about IBR. I have a unique situation that I'd like to hear your take on. I'm wondering what my possible tax bomb could be.

I have about 150K in student loan debt.

I work and live overseas in China. My take home annual salary is about 95K after Chinese taxes. Due to the Foreign Earned Income Exclusion, I do not need to pay U.S. taxes on the first $100,800 I make (this number goes up each year for inflation - it was $92,900 in 2011, for example). So, my agi is zero (well, it's actually about $1000 because of some interest coming in from U.S. savings).

I'm enrolled in IBR, and my monthly payments are $0. I am in my 2nd year of IBR, by the way.

Right now, I'm saving $3.5K/ month and I'm about to buy a house in the States.

Assuming I stay overseas (which is a fairly safe assumption, I think), what would my potential tax bomb be if in 23 years the following was true…

Salary: 200K (before tax exclusion)
Liquid Cash: $200K
Investments: $1 million
Additional Assets: $1.5 million

Thanks for helping me figure this out. One part of me thinks I should up my savings a bit and try to pay the loan off in the next 3 years. The other part thinks that's a horrible idea because the $150K will grow much faster if I stick with the ibr minimum payments for the next 23 years.

What do you think?

[twenty]

Hi everyone,

Thanks for the informative discussion about IBR. I have a unique situation that I'd like to hear your take on. I'm wondering what my possible tax bomb could be.

I have about 150K in student loan debt.

I work and live overseas in China. My take home annual salary is about 95K after Chinese taxes. Due to the Foreign Earned Income Exclusion, I do not need to pay U.S. taxes on the first $100,800 I make (this number goes up each year for inflation - it was $92,900 in 2011, for example). So, my agi is zero (well, it's actually about $1000 because of some interest coming in from U.S. savings).

I'm enrolled in IBR, and my monthly payments are $0. I am in my 2nd year of IBR, by the way.

Right now, I'm saving $3.5K/ month and I'm about to buy a house in the States.

Assuming I stay overseas (which is a fairly safe assumption, I think), what would my potential tax bomb be if in 23 years the following was true…

Salary: 200K (before tax exclusion)
Liquid Cash: $200K
Investments: $1 million
Additional Assets: $1.5 million

Thanks for helping me figure this out. One part of me thinks I should up my savings a bit and try to pay the loan off in the next 3 years. The other part thinks that's a horrible idea because the $150K will grow much faster if I stick with the ibr minimum payments for the next 23 years.

What do you think?

This is an interesting issue. 23 years from now, you'd probably be looking at a 400k-ish loan assuming you didn't make any real payments under IBR. Obviously since your assets at that point would exceed 400k, you'd be on the hook for the full force of the tax bomb. Therefore, in order to reduce the effect of the tax bomb, you'd have to move your liability number substantially, or your asset number down.

As you kind of touched on, your asset number will go down with the foreign tax exclusion on income. There are legal, semi-illegal, and illegal ways to do this. Certain types of retirement accounts are going to be excluded. You might also be able to move your assets over to an irrevocable trust with your children as (eventual) beneficiaries. Avoid "gray" and "black" areas just because the IRS is kind of a bitch about people concealing foreign assets with fraud.

[lacrossebrother]

someone with some time really needs to look up this no capitalization rule.
it was my understanding that if your principal is $150k, the most annual interest you could pay at accrue in any year, no matter the growth of the debt, would be 150k*interest rate. So at the pretty normal 6.7% average, you're looking at $10,050/year * 20 years = $351,000. Assuming the marginal tax rate is 35%, you're then looking at a total repayment of $122,850...which is obviously less than your principal.

[Kronk]

someone with some time really needs to look up this no capitalization rule.
it was my understanding that if your principal is $150k, the make annual interest you could pay at any year, no matter the growth of the debt, would be 150k*interest rate. So at the pretty normal 6.7% average, you're looking at $10,050/year * 20 years = $351,000. Assuming the marginal tax rate is 35%, you're then looking at a total repayment of $122,850...which is obviously less than your principal.

I have been on PAYE for a year and this is how it works. I pay the interest for $250k of loans despite the fact my loans have ballooned upwards.

[Tiago Splitter]

someone with some time really needs to look up this no capitalization rule.
it was my understanding that if your principal is $150k, the make annual interest you could pay at any year, no matter the growth of the debt, would be 150k*interest rate. So at the pretty normal 6.7% average, you're looking at $10,050/year * 20 years = $351,000. Assuming the marginal tax rate is 35%, you're then looking at a total repayment of $122,850...which is obviously less than your principal.

Yeah that's right. Only issue is if he ends up falling out of partial financial hardship the loans will re-capitalize. Under PAYE that's capped at 10% of the original balance but I don't think there is a cap on IBR.

[lacrossebrother]

someone with some time really needs to look up this no capitalization rule.
it was my understanding that if your principal is $150k, the make annual interest you could pay at any year, no matter the growth of the debt, would be 150k*interest rate. So at the pretty normal 6.7% average, you're looking at $10,050/year * 20 years = $351,000. Assuming the marginal tax rate is 35%, you're then looking at a total repayment of $122,850...which is obviously less than your principal.

I have been on PAYE for a year and this is how it works. I pay the interest for $250k of loans despite the fact my loans have ballooned upwards.

Despite being the most prudent financial move, does this nonetheless have any adverse effects on your MIND?