Dear Rick:
My grandson just graduated from Morehouse College. As you may have heard, during the graduation ceremony, the speaker announced that he was going to pay off all the student loans for the graduating class. Obviously, this was a great surprise and it was a wonderful gesture. The question I have deals with any tax consequences that my grandson would have because his loan is being paid off. I am concerned, because my grandson was contacted by a company who told him that unless he did certain things, the money would be taxable to him. The company said that it would cost him $2,500 for their assistance. The company sent him an article about people who had received a free car on Oprah’s show, and they had to pay taxes on the gift. My question to you is whether the money taxable and if it is, is there anything my grandson can do?

Thank you.
Molly

Dear Molly:
First, congratulations on your grandson’s graduation. It is always a great accomplishment when someone graduates college, and you are right to be very proud of him.
With regard to the communication he received from the company willing to assist him for a fee, in my opinion, it is a scam and he ought to ignore it. The situation with the people receiving cars from Oprah is a totally different situation. When Oprah gave everyone a car, the reality of the situation was it wasn’t Oprah gifting a car to her audience members, rather it was a promotion by General Motors. Since this was a promotion from a corporation and not a gift, the IRS was correct to tax individuals who received the car. Receiving a promotion is no different than winning a lottery or winning on a game show. The gentleman who recently won over two million dollars on Jeopardy is going to be taxed on that money. The situation with the student loan payoff is different.

I believe the money provided to pay off the student loans will not be taxable to the students because it is a gift. Under our tax laws, it is not the person who receives the gift who is taxed on the money; rather, it is the person who gives the gift. Therefore, as far as I’m concerned, for those students who are going to have their loans paid off, they will have no tax consequences.

There is a provision in our tax law that says if your debt is forgiven or discharged for less than what the outstanding balance is, the amount of the cancelled debt is treated as ordinary income and is taxable. However, I do not believe this applies in this situation because the debt is not being forgiven or being discharged for less than what is owed. The debt is being paid off in full, and thus it is clear that it is a gift. Because it is a gift, the students will not be taxed.

Of course, whenever it comes to tax law there is a caveat, and there’s one in this situation. According to a statement I read from Morehouse College, the exact specifics of how the gift will be handled are still being worked out. Therefore, something could potentially change. However, I do not believe that the impact to the students will change. Whether the generous donor is going to be able to deduct anything on his tax returns is a different story. Typically, if someone makes a gift to an individual, as in the case at hand, there are no tax benefits to the donor.

At this point in time, my advice to your grandson is to do nothing and wait to hear from Morehouse College on how the transaction is going to be structured. If, for some unlikely reason the way the transaction is structured would require it be taxed to the graduates, whatever they would owe in taxes would be considerably less than their outstanding student debt. Therefore, no matter what happens, it was a wonderful gesture and a great graduation present.

Good luck!

Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.
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