Filing your tax returns can be complicated enough without adding student loans.
They may seem like two separate financial matters, but they often intersect in ways that can significantly impact your financial life.
As a student loan borrower, you may question how your loans impact your taxes and vice versa.
This guide will walk you through everything you need to know about student loans and doing your taxes.
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How Student Loan Interest Affects Your Tax Returns
If you paid interest on federal or private student loans during the tax year, you can deduct the student loan interest on your tax returns.
Here’s how it works:
- The interest deduction lets you reduce your taxable income by up to $2,500 of the interest you paid on qualified student loans in the tax year.
- This deduction applies even if you don’t itemize deductions on Schedule A.
- The loans must have been used to pay qualified higher education expenses like tuition, fees, room and board, books, supplies, and equipment to claim the deduction.
- Income limits apply. For 2022 taxes, the deduction phases out between $70,000 and $85,000 of modified adjusted gross income ($145,000 to $175,000 for married filing jointly).
So, record how much student loan interest you paid in the tax year. The loan servicer will issue Form 1098-E showing the amount of interest paid.
Then, claim the deduction when you file your tax return. Every dollar of interest deducted will lower your taxable income and taxes owed.
Are Student Loan Payments Tax Deductible?
No, student loan principal payments are not tax deductible. The student loan interest deduction only applies to interest paid, not the amount of your actual loan payments used to pay down the principal balance.
Certain student loan repayment assistance programs do provide tax-free benefits:
- Employer student loan repayment assistance up to $5,250 per year is not counted as taxable income.
- Income-driven repayment plans or Public Service Loan Forgiveness payments are not taxed.
- Federal student loan forgiveness programs do not count the canceled debt as taxable income.
But for basic student loan payments, you cannot deduct these amounts on your taxes in any way. The principal payments reduce how much you owe on the loans only.
Claim the Student Loan Interest Deduction
To claim tax returns on your student loans:
- Collect Form 1098-E from each lender, showing interest paid in the tax year.
- Make sure you meet the income limits.
- Complete Form 1040 and include Schedule 1.
- On Schedule 1, enter the total student loan interest paid in the tax year.
- The allowable deduction will be calculated and applied automatically to reduce your adjusted and taxable gross income.
The student loan interest deduction directly reduces your tax burden, so don’t forget to claim it if you paid over $600 in interest during the tax year.
Handling Student Loans When Filing Jointly
If you’re married and file a joint tax return with your spouse, there are some special considerations for student loans:
- You can each claim the up to $2,500 student loan interest deduction separately if you paid interest in the tax year.
- Your combined MAGI as a couple must fall within the income limits to claim the deduction(s).
- Any student loan cancellation or forgiveness will be considered taxable income to the spouse who received the benefit. An exception is Public Service Loan Forgiveness.
- If you do income-driven repayment and file jointly, your combined income will be used to calculate the payment. This may increase your monthly payment.
- When doing taxes jointly, work together to ensure student loan deductions and benefits are handled correctly.
Avoid Problems When Filing Taxes With Student Loans
Filing your taxes when you have student loans can get confusing.
Avoid issues by:
- Gathering Form 1098-E from all lenders before filing taxes. Double-check all interest amounts listed.
- Only claiming deductions and tax credits you qualify for—review eligibility rules.
- Indicating that someone else can claim you as a dependent if appropriate. Dependents cannot claim the student loan interest deduction.
- Recalculating your income-driven repayment after filing if your AGI changes significantly. Your new payment will be based on your tax return’s AGI.
- Note that any loan cancellation will be taxed as income unless it’s through PSLF, Borrower Defense, or another exception.
- Including all canceled and forgiven debt issuances on your tax return. You should receive a 1099-C.
- Paying any taxes owed on canceled student loans that year or making payment arrangements with the IRS to avoid penalties and interest.
With good recordkeeping and an understanding of the rules, you can file your taxes correctly as a student loan borrower and maximize savings.
How Student Loans Impact Your Tax Refund
If you receive a federal tax refund in the spring, you may count on that money toward any expenses.
But if you have student loans in default, your tax refund could be intercepted to pay down the past-due balance. Here is how it works:
- The federal government can seize tax refunds through the Treasury Offset Program to repay debts owed to other government agencies and certain types of loans.
- If your federal student loans are in default, the Department of Education is allowed to intercept your tax refunds. They will take the refund money and apply it to the loans.
- This can happen with federal and private student loans that must catch up on payments. Typically, the loan needs to be in default, which occurs 270+ days past due.
- You will be notified if your tax refund was taken to pay defaulted student loans. This notification should explain how much was seized and which loans were paid down.
- If you were counting on the refund for bills or other expenses, this could disrupt your finances. Avoid defaulting on student loans to prevent tax refund interception.
- If already in default, work on rehabilitation or consolidation to regain good standing, restore aid eligibility, and avoid refund seizures.
Student loan defaults can have ripple effects that impact your finances, like tax refunds. Stay up-to-date on payments to avoid refund interception and get maximum benefit from your annual tax refund.
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Will Paying Off Student Loans Early Reduce Refunds?
What if you don’t have outstanding tax debts to settle but want to pay down student loans aggressively?
If you pay off your loans early, does it eliminate the potential for the student loan interest tax deduction and shrink your future refunds?
The answer is you can still deduct student loan interest even after a loan is paid in full, under certain conditions:
- The deduction applies to interest paid during that tax year, not future years. Paying off loans early stops future interest from accruing.
- But if you paid any interest in the tax year before paying the loan off, that interest still qualifies for the deduction.
- For example, if you paid $2,300 in interest on federal loans in 2022 before paying off the balances in November 2022, you can still deduct up to $2,500 of that 2022 interest when filing taxes in Spring 2023.
- The interest deduction is available for the tax year the interest was paid, even if the loan is paid off before year-end.
So, paying off student loans early will reduce the total interest paid over time but won’t affect the ability to deduct interest already paid in the current tax year.
Pay off loans quickly to save on interest and maximize deductions.
Claiming the Student Loan Interest Deduction After Payoff
Let’s say you fully paid off your student loans in September 2022. Should you still get Form 1098-E from the lender showing interest paid in tax year 2022?
Yes, it’s still important tax documentation:
- Even after a student loan is paid off, the lender must provide Form 1098-E detailing interest paid through that calendar year’s payoff date.
- Form 1098-E should list all interest paid from January 1st until the payoff date.
- When you file taxes in Spring 2023, use this form to claim the student loan interest deduction for 2022, deducting up to $2,500 of interest paid before repayment was complete.
- You won’t receive another Form 1098-E for that loan in future years since no more interest will accrue.
Refrain from assuming early repayment means forfeiting the interest deduction that tax year.
The Form 1098-E for the year of payoff will provide the info needed to deduct the pre-payoff interest when filing your return.
Can Student Loan Cancellation Be Taxed as Income?
For federal student loans canceled through income-driven plans, Public Service Loan Forgiveness, Borrower Defense, school closures, or disability discharges, the amount forgiven is not taxed.
But there are certain situations where canceled student loan debt can count as taxable income:
- Private student loans that are settled or forgiven may be taxed on the amount discharged unless proof of insolvency is provided. Lenders will issue a 1099-C.
- Federal Parent PLUS loans discharged due to the death of the parent borrower are not taxable, but discharged Parent PLUS loans due to the student beneficiary’s death are taxed.
- If an employer repays your student loans, and the payment exceeds $5,250 for the year, the amount above that threshold is considered taxable income.
- The Biden Administration’s one-time federal student loan cancellation will not be taxed as income.
So, consult the forgiveness program’s rules to see if canceled amounts will be treated as taxable income.
If so, report it correctly on your return and make arrangements to pay any additional taxes owed.
Are Student Loan Rewards and Refunds Taxed?
Is this taxable income if you earn rewards for making student loan payments on time or receive a refund of overpayment on federal loans?
- Rewards or refunds related to federal student loan payments are not subject to income tax.
- Refunds represent your own money being returned, not new income.
- Small rewards meant to encourage repayment are more like rebates, not income.
However, rewards for opening a private student loan or moving assets to certain banks may count as taxable income if over $600.
Ask the lender to provide the reward. For federal loan-related refunds and rewards, you can accept them tax-free.
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The rules around student loans and tax returns may seem confusing. However, understanding them can help you maximize savings and avoid missteps when filing your return.
Refer to this guide if you have questions about the interplay between student loans and taxes.