David Donelson was divorced and almost $400,000 in debt when he moved his life and career to Dubai. He wanted to “escape New York City and travel the world,” and also put his life back together, which meant, among other things, finally confronting his six-figure bill from dental school at Tufts University.
“People of our generation are in a kind of servitude no one else around the world has,” he said. The 37-year-old knew there would be tax benefits to living and working abroad, but he was surprised when the lawyer he hired to help him with his debt said he could reduce his student loan bill from thousands of dollars a month to about $300 a month simply because he was living in a different country.
Even those making six figures can greatly reduce their bills using the loophole Donelson uses. Meanwhile, it also allows for people making less than about $100,000 a year to submit official payments of $0. What’s more, after years of “paying” creditors $0 month after month, they can erase their debt completely. At least in theory.
Young people caught up in the $1.5 trillion student loan crisis primarily cope through willful ignorance. Some with particularly hefty debts have moved to Europe in hopes of never having to think about what they owe again. Last month, CNBC published an article about a guy who went slightly further, literally moving from Colorado to a village in the Indian jungle where he thought debt collectors wouldn’t be able to find him. Just this week, a local paper in Pennsylvania chronicled the woes of a 30-year-old man who purchased a one-way ticket to China. But running away won’t erase anyone's debt. It’ll still be there—and it will only grow.
“If the goal is to go abroad so that you don’t have to pay your loans, then that’s just stupid,” said Joshua Cohen, an attorney who focuses on student loans. Instead, what he suggests is taking advantage of something known as the Foreign Earned Income Exclusion, which is a tax credit worth about $100,000. If you’re living and working abroad, then you technically don’t have an adjusted gross income in the United States. And if you’re on an income-based repayment plan for your student debt, that makes your monthly loan bill zero dollars.
What’s more, borrowers who are on these plans are eligible to have their balances forgiven after either 20 or 25 years, depending on the plan. So in theory if you lived abroad for that long, you could return after that time and have your debt erased, without having paid any of it. The rub is that the IRS then counts the wiped balance as taxable income—meaning the forgiveness comes with a nasty bill from the federal government—but Cohen and other experts claim that you could technically claim insolvency when that time came if you had assets that were worth less than the “tax bomb,” as it’s known.
We won't know how the IRS will respond to people trying to declare insolvency on their student loan tax bomb until 2033, which is when the first Obama-era loan forgiveness laws will become relevant. Congress could get wise to the loophole before that and take action to prevent people from abandoning their debts when they move abroad, as Australia did in 2015. More likely, the IRS may decide that you can’t avoid the tax bomb by claiming insolvency.
So what happens if someone plans their whole financial life around this theory, and then wakes up to discover they owe the government a huge sum?
“That is an anxiety of someone who has not saved much,” said Travis Hornsby, the accountant behind a company called Student Loan Planner. “If you have a 20 percent savings rate or higher, your net worth is going to be much higher than whatever the tax bomb would be, or even if they just gave you a lump sum bill. You would have the asset levels to pay it if you absolutely had to.” In other words, provided you’re saving the money you would have used to make your loan payments (a big if, but no matter), you’ll be able to pay off the IRS when your loan is forgiven. Hornsby advised Donelson on his debt, and estimates that he’s coached about 50 other people into taking advantage of the tax credit.
Donelson himself is trying to figure out whether or not he’s going to pursue forgiveness or try to aggressively pay down his loans once he returns to the US. Right now he’s putting about 0.5 percent of his income into a brokerage account just in case he decides to take a path that leads to him getting hit with the tax bomb. He’s decided to repatriate to the U.S., and the option he chooses depends on how successful he ends up being when he returns stateside—how soon he opens a practice, how much money he ends up making. The choice is between owing money to the companies who hold his loans, or someday having to pay the U.S. government a ton of money.
“If you’re going to have a student loan balance, you have to decide whether you want to be in debt with the government and the IRS or someone else,” he said. “It depends on who you want to dance with.”
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