Sen. Reid proposes changing tax law to pay for lower rate on student loans

Senate Majority Leader Harry Reid (D-Nev.) on Tuesday introduced a bill that would keep the interest rate on federally subsidized student loans at 3.4 percent for another year by closing what he argues is a tax loophole on income earned through so-called S-corporations.

Reid's Stop the Student Loan Interest Rate Hike Act, S. 2343, is the latest proposal from Democrats to stop the scheduled jump in Stafford loan interest rates from 3.4 to 6.8 percent that is set to take effect in July.

Another proposal from Sen. Jack Reed (D-R.I.) would permanently extend the 3.4 percent interest rate, but that bill does not offset the cost of the extension.

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Under current law, businesses organized as S-corporations don't pay corporate taxes, and income earned is passed through to shareholders, who report that income on their personal tax returns. But if these shareholders are also employees, they can choose to treat some of their income as business profit — not salary, which lets them escape payroll taxes.

Reid's bill would eliminate that flexibility by requiring those with incomes over $250,000 to include, for purposes of employment taxes, income received from an S-corp or limited partnership interest in a professional service business. This change, however, would only apply to S-corps and partnerships in which more than 75 percent of its gross revenues come from the service of three or fewer shareholders, and only those in fields where most of the earnings come from the performance of services, like those involving lobbyists and lawyers.

According to a Senate Democratic aide, the permanent change would raise $6 billion over the next decade, enough to pay for the roughly $6 billion cost of extending the lower interest rate for student loans.

The aide cast the change as not raising anyone's taxes, but rather one that closes a loophole that "forces wealthy tax cheats to pay what they already owe." 

Senate Minority Leader Mitch McConnell (R-Ky.) blasted Reid’s proposal as an attack on business.

"Democrats want to pay for [lower loan rates] by raiding Social Security and Medicare, and by making it even harder for small businesses to hire," McConnell said. "We happen to think that at a time when millions of Americans — and countless college students — can’t even find a decent job, it makes no sense whatsoever to punish the very businesses we’re counting on to hire them. It’s counterproductive, and it’s wrong."

McConnell said Democrats were really just seeking political gain by introducing legislation that Republicans would oppose. 

"Let’s be honest," McConnell said. "The only reason Democrats have proposed this particular solution to the problem is to get Republicans to oppose it, to make us cast a vote they think will make us look bad to the voters they need to win the next election."

Reid called on both parties to agree to keep student loan interest rates low, without mentioning his specific proposal. Reid reminded people that the 2007 cut from 6.8 to 3.4 percent was signed by former President George W. Bush.

"Everyone should understand this is a bill that was signed by President Bush," he said. "So we need to go back to what President Bush signed. We cannot have these rates go up.

"If we don't act by July 1, more than 7 million students will be forced to pay an average of a thousand dollars more each year for these student loans."

On Monday, GOP presidential candidate Mitt Romney said he supports a temporary extension of the lower student loan interest rate, but Republicans have not yet said as a group how or whether to pay for it.

Obama traveled to college campuses this week to urge Congress to pass legislation preventing the interest rate increase. McConnell said Obama is trying to vilify Congress to distract young voters from his record in office. 

"For a great many of them, the excitement and promise of President Obama's campaign four years ago has long since faded as their hopes collided with an economy that he's done so much to reshape," McConnell said. 

"It's understandable he'd want to make them believe the fairy tale that there are villains in Washington who'd rather help millionaires and billionaires than struggling college students. But that doesn't make this kind of deception any more acceptable."

— This story was updated at 11:50 a.m., and again at 4:03 p.m. to clarify details about the tax change.

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