The importance and value of education is beyond cavil. The federal government realizes this, the candidates in the primaries realize this, and most importantly the citizens (i.e. the voters) of the United States realize this. In fact, the issue of education potentially could make or break one of the candidates in the November 2000 Presidential Election.

Unfortunately, and as many of the candidates for public office themselves note, the cost of higher education is steep. CNN recently observed that public university tuition costs have risen 51% and private university tuition 34%, over the past ten years. Tuition, alone, can exceed $25,000 an academic year. Add to this the costs of food, room, board, books and living expenses, the cost of education can exceed $35,000 a year.

The costs incurred for higher education can become exceptionally staggering when a young adult pursues graduate education. Young adults without the benefit of a scholarship, trust fund, parents with large amounts of disposable income or a large bank account, must finance these substantial costs or forego the added education. The near term solution has been provided by the federal government, which has guaranteed billions in student loans to help finance education. But the near term solution carries with it long-term costs which many if not most students fail to appreciate when they take out their loans.

The government encourages its citizens to go back to school by providing and publicizing that it offers tax incentives.² The problem with this picture -- of a citizenry provided with a means of affording the substantial and escalating costs of higher education -- is that it is not as perfect as President Cliton made appear in his final State of the Union Address. What many people do not realize, and what the President's address failed to mention, is that, when it comes to education, not only are the costs significant but educational loans carry with them interest which cannot be deducted in computing federal income taxes. Additionally, the government has put mechanisms in place to make certain that the loans (and every cent of interest) are repaid in full. As for the tax incentives for education, they rarely apply.

If you have not signed your life away (or at least the next thirty years of it), or even if you have, you may want to consider the following facts about student loans and decide if your elected representatives should change the prevailing situation.

The policy of our nation's law makers toward student debt is simple. The federal government (playing the role of the lender or guarantor) wants back every lent dime, with interest. To assure this, any tax refunds owed to the student will be paid instead directly to the government/lender when the student loan debt is reported as past-due. The student/debtor/taxpayer has no rights in this circumstance. In fact, even if a mistake has been made as to whether money is owed or the amount of the debt, the student/debtor/taxpayer is barred from even arguing that the claimed amount is not owed. If the student/debtor/taxpayer wants to prove that he or she does not owe the debt (and thus should receive the tax refund against which the debt was withheld) the student debtor must take the issue up with the lending agency allegedly owed the disputed debt; not the IRS.

To make the situation more difficut for the student debtor, Congress adopted section 523(a)(8) of the Bankruptcy Code. Section 523(a)(8) allows the government to treat student loan debt differently than other types of debts by making it virtually impossible to discharge a student loan in a bankruptcy proceeding.

The only time student loan debt will be discharged is when the student can prove "undue hardship." What does this mean? The answer depends upon the domicile of the student,³ but generally a student/debtor will be excused from paying back the loan (i.e., the loan will be discharged) only if he or she can prove that: (i) the student cannot maintain a minimal standard of living if forced to repay the loans; and (ii) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and (iii) the student made a good faith effort to repay the loans.⁴ In other words, a student loan will be discharged only if the student/debtor's financial condition (current and future) is hopeless!

Of course, no one advocates the proposition that a valid debt should not be repaid without good reason. At the same time, our social and political system encourages entrepreneurship, which often results in extensive borrowing for business investment that cannot be repaid and is thus reorganized for later partial payment or fully discharged in bankruptcy proceedings.

Education is the ultimate form of personal entrepreneurship. Surely, it deserves a reasoned level of fiscal accommodation by the federal government.

In many instances, the government provides taxpayers with some relief. Typically, these take the form of a tax credit, or a tax deduction or both.⁵ These pinches of salvation, however, are limited and do not apply to everyone.

In January 1998, a tax credit, enticingly called "The Lifetime Learning Credit" became available to higher education students under Section 25A of the Internal Revenue Code. Under this arrangement, the federal government provides the ambitious student with a $1,000 tax credit. At first blush, it might seem that the government made a modest accommodation to encourage students otherwise unable to afford graduate education to invest borrowed dollars in the pursuit of graduate degrees instead of going into business or taking jobs immediately upon completing undergraduate education. But, the Lifetime Learning Credit rarely provides a benefit to those who attend school, especially graduate school, while they work. The full credit is available only to individuals who earn less than $40,000 per year and phases out ratably so that no Learning Credit is available to a night student who earns $50,000 per year.

The tax credit is available only to cover tuition and feees required for enrollment and does not apply to the repayment of educational loans. Students who borrowed to finance their educational costs must look elsewhere for tax relief.

As of 1998, the federal income tax law provides a limited deduction, but only for the interest paid on what the tax code classifies as "Qualified Educational Loans." The tax deduction becomes available when the loan goes into repayment and limits the annual student loan interest deduction to a maximum of $2,000. When dealing with student loan debt that can easily equal or exceed $100,000, that represents only a portion of the interest.

Unfortunately, even this limited tax deduction amounts to little more than lip service because many if not most graduate education borrowers cannot surmount the three obstacles in the fine print that governs claiming the tax deduction. First, the full credit is available only to those taxpayers with a gross income of $40,000 or less a year. Second, the amount of the credit diminishes as the taxpayer's gross income exceeds $40,000 and vanishes when the taxpayer's annual income exceeds $50,000. Third, the government will only let the taxpayer deduct the first 60 months (5 years) of interest payments.

Taxpayers enticed into carrying large educational loans, often well over $100,000, genreally do not qualify for the deduction. For example. the national median starting salary for lawyers is $60,000. This means that a majority of students coming out of law school are paying more than a week's worth of income just toward service student debt, without tax benefits. Economically, given their loan and tax burdens, they often would have been financially better off to have skipped graduate education. A tax deduction for interest incurred to pay for learning would be well applied to them.

The advice I have for the students who do not qualify for the credit or the deduction is threefold. First, if you are employed and going back to school and want to obtain a graduate degree, you should examine whether you can meet the tax rules for deducting the tuition bills as expeses necessary to your trade or business. Admittedly, this may not be easy to do. Second, if you own a home, consider taking out a home-equity mortgage and paying off the entire amount of your student loans. If you do, you may be able to take advantage of the fact that, unlike education loan interest, interest payments on a home equity mortgage are deductible. Third, write your Congressman and tell him or her that you know the economic facts of life about students. Tell your Congressman that elections come often for Congress and that students deserve a tax break at least comparable to that given to home owners. Ask your relatives and friends to do the same.

1. This article is only a basic resource. It was written solely for informative purposes, reflects the personal opinion of the author and should not be relied upon as a legal opinion.

2. Our federal income tax system does more than raise revenue for the federal government. The government uses the tax laws as social planning tools. For example, to encourage citizens to own homes, the government provides deductions for home owners but not for home renters.

3. There is a split of authority, among the circuits, concerning the meaning of "undue hardship." This article will not discuss the different interpretations of the standard.

4. See Brunner v. New York State Higher Education Services Corp., 831 F.2d 395, 396 (2d Cir. 1987).

5. The difference between a tax credit and a tax deduction is straightworward. A tax credit is subtracted from the amount the taxpayer owes in taxes. A deduction, in contrast, is subtracted from the taxpayer's gross income in order to determine the taxable income on which tax will be computed.

6. The $40,000 figure is based on the assumption that the taxpayer is filing his or her own return and that the filing status of the taxpayer is unmarried. The income restriction on married taxpayers filing a joint return is $80,000.

7. The $50,000 limitation is increased to $100,000 when the student is married and files a joint tax return.

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